Before venturing into any investment product, the most important part is to know fully well what you are getting into. You need to judiciously weigh the pros and cons and see whether it aligns with your investment objectives. Stock market investing is no different. The stock market has the potential to fetch high returns and can turn into an excellent avenue provided you have a strategy and steer clear of a few common pitfalls. Let’s see what these pitfalls are and how to avoid them to get the best bang for your buck in the stock market.
Mistake Number 1: Investing With A Trader Mindset.
This basic difference in being a trader and an investor is that an investor must keep a long term perspective. If you are entering the market with the expectation of making quick gains within a few months you may be disappointed. Learn to differentiate between speculation and investing. There are no quick gains in an equity market and profits take a long time to grow and accumulate.
As an equity investor always remember to give your investment atleast a time frame of 5 years to mature and start giving results, because any time less than that is too early to predict the growth of a business. Until a company grows the share price won’t grow. And there won’t be any profits from your investments. What would be the result of this? Your portfolio will go down, you will sell and exit in haste without giving your investments sufficient time to mature and lose on the opportunity to create wealth.
Analyze a company based on its strengths, weaknesses, opportunities, and threats ( SWOT analysis), if you find yourself assured on the above-mentioned parameters and truly believe in the potential of the company then don’t relinquish the stocks due to short term market volatility.
Mistake Number 2 : Buying Based On Recommendations
More often than not we turn to our well-meaning friends and folks for advice on important matters in life and finance is no different. However, when it comes to stock investing, banking upon the advice of your friends and simply buying stocks that they bought is not be the best way. This doesn’t work because your risk profile and financial objectives may be starkly different from the other person and what has worked for him may not work for you. So soak in all the information but conduct your own due diligence about the company and convince yourself thoroughly. Only when you feel your objectives align with that of the company should you go ahead and invest.
Mistake Number 3: Emulating A Successful Stock Investor’s Portfolio
Consider this, you read about a successful stock investor’s story, such as Rakesh Jhunjhunwala and google his portfolio. The search results show his portfolio. You decide to buy the shares that are mentioned in his portfolio because surely if he has invested in them and made a name for himself in the stock market, then what’s wrong in imitating right? Wrong! This is one of the most common mistakes retail investors do. In order to bypass the research and homework to see the best fit for themselves, they try and copy the portfolio of a successful stock investor and invest in the same companies. This approach is faulty due to the following reasons –
- You don’t know the entry point – Whenever you invest in a company, it is important to know at what level should you invest. When the stocks are listed in the portfolio, who don’t know when were they bought or at what price were they bought and it may or may not make sense for you to buy them at this particular moment. For instance, the person whose portfolio you are trying to copy may have bought the stock when its value is Rs 20 and now its value is Rs 100. So now if you go ahead without thinking and buy it at the same price, you may incur a loss when it’s value comes down. Needless to say, it’s super important to know the right price at which you should enter, the amount of risk you should take and the right time to exit as well.
- Secondly, if you are searching on the internet for the portfolio of a famous stock investor, certainly this information is publically available to other retail investors as well. Chances are this has already led to an increased price of the shares. Needless to say, you aren’t doing anything different that would allow you to make more money. So you won’t benefit from such a strategy in the long run.
- The most important reason why imitating someone’s investing style and strategy doesn’t work is that not the entire portfolio of a person is public. Whenever a big investor invests in a company, retail investors don’t know anything about it till the moment, they earn more than 1 percent shares of the company. When someone’s holding in a company becomes more than one percent it has to be made public. So it’s a huge possibility there are multiple stocks in their portfolio that you may never know and you will have a half baked portfolio based on incomplete information.
Mistake Number 4: Not Knowing When To Sell
Consider this, you bought shares of a company a few years ago, when the price of a share was Rs 100. The company ran into some trouble and the prices came down, so you bought more shares. The prices fell even further when some other issue came to light and you went ahead and bought more shares. Finally, you reached a point where the share price reached an all-time low. Now you have multiple shares and no buyers, ergo you have incurred a loss. This is a situation many retail investors might be familiar with. While it’s good to stick to your guns when you have decided to invest in a company, a prudent investor also knows when to let go.
The problem occurs when you get emotionally invested in the company and ignore the obvious red flags. While “ buy right, sit tight” holds true, keep your wits about you when you see the fundamentals of the company are being compromised. How do you know if the fundamentals are changing? Simple, look out if there is any sustained underperformance quarter-on-quarter or if the utilization of capacity is going down or if the non-performing assets (for banks and other financial institutions) going up, or if there is any sudden or abrupt exit of the senior leadership, etc. In such a scenario you should consider an exit.
Mistake Number 5: Putting All Your Eggs In One Basket: Not Diversifying Enough
Another common mistake that investors do is invest a large chunk of their capital in buying stocks of only one kind or of a single company and then incurring a loss when the portfolio goes down. Even if you look at the publicly declared portfolio of successful stock investors like Rakesh Jhunjhunwala, you will see he has stocks across industries and businesses. Diversification spreads out your risk; it makes sure if some stocks are going down, others gain and nullify your loss, so your portfolio remains balanced.
To sum up, these are some obvious pitfalls to avoid while entering the stock market. Always keep a long term perspective and conduct due diligence when shortlisting a company. Once you have based your bets on a company with strong fundamentals, invest and allow sufficient time for your investments to reap rewards. Stay patient, stay prudent and enjoy the journey!
Disclaimer: The views expressed in this post are that of the author and not those of Groww