Top 6 Investing Mistakes of All Times
Meeting with individual investors over the years has taught me much about investing mistakes. No matter how you classify investors (i.e. fundamental, technical or confused), the mistakes they make are almost invariably identical.
While some mistakes are the result of simply not knowing what to do, many are the results of either (i) losing interest; or (ii) getting overly greedy or fearful, particularly when the tide turns. In either case, much money is lost when people assume things will simply take care of themselves.
Below I talk about 6 most common investing mistakes particularly when it comes to stock investing:
- Not Being Adequately Diversified
I am often surprised how many investors end up getting invested in just 1 or 2 stocks. Major cause: I have heard of something called ‘Cost Price Average’ theory (discussed here); the approach is senseless and noble at the same time. Senseless because it’s a perfect case of good money being thrown at bad money; noble because it graciously places confidence in a stupid decision which did not quite work in the first place.
Understand the importance of diversifying investments among different asset categories and industries.
While diversifying, make sure you own at least 10-15 individual stocks (with no more than 10-20% in any one stock). Choose your sectors carefully or invest in broad-based mutual funds that diversify the money for you. I am a big believer that if investing is not your core activity, then your core portfolio should be in high quality mutual funds, of course you can choose to invest a portion of it in individual stocks yourself. And even though I talk of 10-15 stocks above; if done correctly, even a 5 stock portfolio accomplishes adequate diversification.
- Being too diversified
Exactly 2 weeks back, I was introduced to a new client who said that despite investing in so many funds he was not making any higher return than he would make in a fixed deposit. I told him this – it’s because you are invested in so many funds that you are not making any higher return than you would make in a fixed deposit.
Get ready for this – his portfolio had 34 mutual funds and some individual stocks. Of course, he had no clue how he was monitoring things.
The maximum number of funds you should own is 3. Not 4. You can take the number of stocks up to 10 but not much more.
- Getting Involved With Your Emotions
I will not talk about fear and greed anymore – you know about it. How you deal with such forces is entirely up to you. Go read books and blogs on behavioral finance. It is unlikely they will help you at first but keep reading them again and again, may it’ll work.
Signs of being an emotional investor:
- Refusing to take a loss, i.e. holding on to a stock, thinking it’ll come back at some point (without any attention being paid to changing fundamentals)
- Selling stocks because of correction in stock prices (without any attention being paid to changing fundamentals – read about ‘overreaction and herding’ in the post above).
Making tough investing decisions requires the ability to rise above emotions. May be for this reason it is difficult for people to manage their own finances as well as professional money managers do.
- Cost Price Averaging
There is a notion that averaging brings down the purchase cost and hence it cuts your loss and gives you a better chance to cover up and then make profits. Something like that. That you would be able to sell it at some marginal profit or at least closer to your cost price. Ok listen – Buy the best stock and not the stock that you own already only because it is now available below your original purchase price. What’s wrong with you?
Example – Unitech, suppose you invested in 1 share at Rs.38.60 in June 2014, then “averaged” by buying one more share at Rs.22.50 in August 2014 and further averaged by purchasing another one share at Rs.18.15 in November 2014 so that now your reduced “average cost” is Rs.26.
But, what purpose has that served? Today the stock is quoting around Rs.4.11, down by a phenomenal 84% from your reduced “averaged cost”.
Be careful however – chances are that your emotions are making you buy more of the stock that you already own.
- Already Fallen / Risen So Much – Can’t Fall / Rise Further
This is Classic.
A stock might have fallen / risen “considerably” over a period of time. This has nothing to do with how the stock will perform in future. Period. Please start believing in this.
Consider the stocks of Unitech and Titan.
- Unitech fell from Rs. 38.60 in June 2014 to Rs. 22.50 in August 2014, a massive fall of 42% in just two months. Any investor who might have believed that it can’t fall further because it has fallen 42% in 2 months and hence purchased more shares will have a story to tell now that the stock is quoting at Rs. 4.11.
|June 2014||Rs. 38.60|
|August 2014||Rs. 22.50|
|November 2014||Rs. 18.15|
|March 2016||Rs. 4.11|
- Titan rose from Rs. 56.54 in August 2007 to Rs. 150.30 by September 2010, amazing jump of more than 166% in 3 years. Anybody, thinking that the stock has risen so much and therefore cant rise further (and sold it); may also have a story to tell. Titan was quoting at Rs. 350 a few minutes back. Keep in mind that 2010 – 2016 (to my mind) have been the worst years for equities in many decades. I take the example of Titan cause I’ve had it for many years. Of course there are many other stocks that have beaten the returns generated by Titan during this period, hands down.
|August 2007||Rs. 56.54|
|September 2010||Rs. 150.30|
|March 2016||Rs. 350.00|
- Timing the Stock Market
If there was a full proof way of timing the market, it would be the most widely taught course at business schools. There is a reason that such is not the case.
Successfully timing the stock market is as much a random chance, as winning a lottery. Although, those who are able to time the market successfully will tell you otherwise; just how winners in a lottery regularly try to explain their secret formula of selecting the winning number. No matter how many trends or past records you look at, you will never be able to predict future. If at all, you may find yourself on the right side of a random swing. Enjoy it, but don’t get carried away. Instead of trying to time the market; spend more time in the market.
Remember – there is no secret formula to winning the lottery.