“Want to multiply your money? Invest with us for high returns” How many times has this happened to you that an advertisement like this has been floated and you felt tempted! It is completely understood that if you are a novice investor, you got pushed over by this statement.
When we’re new in the investment world, we are so flummoxed by the idea of high returns and fatter wallets that multiplication of money really dazzles us.
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 and not chase returns. Stock market investment or investment into equity-based funds is no different.
The stock market has the potential to fetch high returns, sometimes in double digits in a longer-term and can turn into an excellent avenue provided you 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.
Here we will help you to understand common investment mistakes to avoid when you are investing in stocks.
In this article
Mistake 1: Investing With a Trader Mindset.
There are no free lunches and there is definitely none in stock market investing. If you are looking to make quick gains, then you are not in the right place. This is where the difference between a trader and an investor becomes essential. While a trader engages in ‘buy and sell’, an investor focuses on ‘buy and invest’.
This basic difference in being a trader and an investor is that an investor must keep a long term perspective. Expectations of quick gains might not fare well and it becomes important to differentiate between speculation and investing.
Volatility and cyclical movements might scare you if you are a new investor. Say you had entered the markets last year when the benchmark indices Sensex and Nifty were up by at a certain percentage, the current situation will ring alarm bells for you.
Both the indices are down by at least 25% or more since 2020 began. You might think you should redeem your investments because you are losing money but this might be a wrong assessment of the situation. Your money needs to be invested for at least 7-10 years for your money to show any returns.
Markets will always have its share of ups and downs and they are a part of its cyclical nature. Your money needs to stay invested for a long period of time. Early redemptions are one of the most important investment mistakes to avoid.
Until a company grows the share price won’t grow and you need to allow the company and its stock the time to grow. What would happen if you actually give in to your irrational fears: 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.
Mistake 2: Chasing returns
Chasing returns while picking a stock is one of the most common investing mistakes. Always remember that stock movements are cyclical. They follow their own journey of ups and downs.
If you invest in a stock or equity fund because it is giving high returns at a given time period, it is not always certain that you will land up in the right investment. It might be a momentary bull run. You need to do a thorough study of the company, its growth objectives, business model, management and other such factors.
Many times a company that fails in one or more of these factors may also be seeing high valuations in their stock. Chasing returns is equivalent to blind investing.
Mistake 3: Getting emotionally invested in a company
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?
Couple of red flags you can look out for are if there is any sustained under performance quarter-on-quarter, if the non-performing assets (for banks and other financial institutions) are going up, or if there is any sudden or abrupt exit of the senior leadership, etc.
If you cannot do it on your own consult a professional advisory and then make a decision. Look at organisational factors of a company and do not chase returns.
Mistake 4: 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 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 5: Emulating a Successful Stock Investor’s Portfolio
Consider this, you read about a successful stock investor’s story, such as Warren Buffet 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 investing mistakes retail investors make. In order to bypass the research and homework to see the best fit for themselves, they try to 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 you should invest. When the stocks are listed in the portfolio, you may not know when they were bought or at what price they were 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.
A mismatch in investor profiles and objectives – It is not necessary that your risk profile and objectives will be in line with the famous investor you are trying to copy.
He may have more finances at hand and may have a higher risk profile, meaning he can afford to take more risks and may have invested in a particular stock. You aping his investment will land you in a soup.
He may have invested in a risky stock because he can afford to do that financially. If you copy his strategy, you will lose your money and determination to invest in the future.
The entire portfolio may not be public – Another reason is that the entire portfolio of a person is never 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.
Information is ‘public’ – Finally, 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.
Bonus : Not Diversifying Enough
Another common mistake that investors make is to 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. Do not invest in a company just because a stock market guru has invested in it or it is giving high returns currently. Once you have placed 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!