5 common investment mistakes to avoid5 min read . Updated: 01 Jun 2015, 09:44 AM IST
Here are five errors of investing that you can easily sidestep. Understand them to avoid them
If you are constructing your own investment portfolio, chances are that you are going to make mistakes. The effect of these mistakes can be an underperforming portfolio and inadequate funds to meet goals, or the portfolio being too risky relative to what you are comfortable with, or the funds you have accumulated being unavailable when you actually need them, among others. If you know what to watch out for, then it may be easier to protect your portfolio from their effects.
Inertia in managing your money can manifest itself in many ways. Holding too much cash, or postponing investments may mean that your savings are not working hard enough for you and the returns that your portfolio is earning is lower than what it could be. Similarly, when you are reluctant to take action to rid your portfolio of investments that are poor performers, you are condemning your money to earn lower than what it can. “People choose to park money in fixed deposits and recurring deposits, which usually give post-tax returns of 6-7%. This is lesser than inflation," said Vivek Shah, founder and chief executive officer, Finrise Financial Planners.
When you take no action to rebalance your portfolio, your portfolio is probably exposed to more risk than what you can take on. Inertia in making and executing investment decisions will impact the level of returns and risk that your portfolio has, which will directly affect your ability to meet goals.
While it is difficult to hit the goldilocks spot on perfect diversification, most portfolios are either over- or under-diversified.
If you hold investments in many stocks, mutual fund schemes, deposits, bonds or other products, with each being only a small percentage of your total holding, then you are over-diversified. Often, you may not even know what you are holding—there may be a lot of duplication. For example, you may have many large-cap mutual fund schemes, many of which may be investing your money, separately, in the same stocks.
Moreover, if you have too many investments, you will find it difficult to track them. This could also mean that you are holding on to losers.
Having too few investments is also dangerous. Holding all your money in one or a few investments makes your portfolio’s returns highly sensitive to the performance of each investment. If your portfolio is concentrated in one asset class, say, debt, you may not enjoy any benefits of opportunities arising in other asset classes such as equity. Different asset classes will keep the portfolio afloat at different times, instead of it sinking with the poor performance of one or few investments.
If you look closely you will be able to identify gaps in your portfolio which can be corrected by diversification. Hold as many investments as required that gives you exposure to different asset classes, sectors, styles and segments without duplication.
“It is also critical to diversify within the same asset class. But you need to justify the diversification and reduce the volatility within any particular asset class," said Surya Bhatia, a Delhi-based financial planner. “For example, within equities, you can diversify across large-cap, mid-cap and multi-cap mutual fund schemes. Try to create a portfolio across various asset classes that gives you diversification at a broader level," added Bhatia.
It is good to be flexible with how you will use your investments to meet your goals and needs. But more often than not, this exhibits itself in using long-term savings for short-term or unexpected needs. Think of all the times you have withdrawn or taken a loan from the provident fund account, insurance policy and other long-term deposits to meet some unplanned expenditure.
While drawing on savings to meet your needs may be justified, it is equally important to have the discipline to replenish or repay the funds drawn as early as possible. But what happens is that you think of this as your own money and feel no pressure to repay or make good the amount withdrawn. When you do that, you are depriving yourself of the benefits of compounding and growth that long-term investing brings to your portfolio. Invariably, it is your retirement corpus that bears the brunt of the indiscipline and you may find yourself short of funds at a stage when you can neither borrow nor find any other source of income.
Moving money to the current best-performing asset class or investment without considering the long-term consequences is a sure-fire way of going wrong in meeting your goals. Consider how you will meet your goals if you find that your portfolio is equity-heavy at a stage when you have to pay for your children’s education or have to make a downpayment for a house or meet the wedding expenses, and markets are down. The funds that you have accumulated for years would have depreciated just when you needed the money. “It is important to move investment from equities to debt about a year before the goal target date, so that your portfolio is protected against any last-minute volatility," said Dilshad Billimoria, founder and chief financial planner, Dilzer Consultants Pvt. Ltd.
Select investments based on the time horizon of your goals, irrespective of which investment is currently doing well. Watch out for the effect of a run-up in one asset class on your portfolio. If equity runs up then the proportion of your total portfolio in this asset class will also inflate and make it more risky. Rebalance your portfolio periodically to make sure that it continues to reflect your preferences for risk and return.
“Asset allocation plays a pivotal role. The factors that need to be considered before choosing an asset class are age, risk, profile, goal and time horizon," said Billimoria. “Regular portfolio re-balancing will ensure that goals are met in accordance with the timelines specified," she added.
Making decisions by looking at only one of the investment’s aspects may result in unsuitable products in your portfolio. Considering only the returns from equity without looking at the volatility, for example, may result in more risk than you are comfortable with. Or, looking at the higher interest offered by a debenture without considering the credit risk and low liquidity of the instrument, or opting for guaranteed products and condemning your portfolio to earn low returns, all mean that you may not be in a position to meet your goals. Consider the risk, returns and time horizon of a product before choosing it.
Your saving and investing activity should always be driven by goals. Mistakes and oversights can derail your plans. But if you know what to watch out for, then you can take precautions to avoid them as far as possible. Automating your investments, inculcating the discipline of periodically monitoring and rebalancing portfolio and investing only after evaluating all aspects of a product for suitability can go a long way in helping you sidestep common investment errors.
It may also be a good idea to use the services of an adviser to manage your portfolio. While there is a cost attached to the service, in the long run, the benefits may far outweigh the costs.