Investing money is a process that requires an investor to plan, adopt a disciplined investment strategy and have the perseverance to weather the volatile periods during the committed time horizon. Although many of us find investment process quite cumbersome, in reality, it is a simple process provided we follow certain basic principles at all times. Unfortunately, not many investors do so and hence end up making too many mistakes thus derailing their investment process.
For example, it is quite common to see investors trying to buy low and sell high despite it being a proven fact that even the professional fund managers find it difficult to time the market consistently. Moreover, it is ironical that when the market presents great long-term investment opportunities, the same investors get cold feet. Clearly, their fetish for catching the market bottom often makes them vary of taking the plunge.
Similarly, there are a few other common mistakes that cloud investors' investment decisions. If you are one of those investors who have been committing investment mistakes, here is how you can avoid them:
Don't look at investment options with rose coloured spectacles
While there is nothing wrong with expecting the best possible returns on your investments, it is important to know about the potential and the risk associated with different asset classes in your portfolios. Many investors make the mistake of focusing only on the returns and ignoring the attendant risks. This not only causes a mismatch between the reality and expectations in terms of returns but also makes it difficult for them tackle the volatility. No wonder, they often panic and abandon their investment process abruptly, thereby, either suffering huge losses or failing to achieve their important investment goals. To avoid a situation like this, the key is not to underestimate risk and/or overestimate returns. Therefore, you must understand the potential and the risks associated with different asset classes so that you have a clear idea about the risk you are likely to be exposed to and the kind of return you can expect from your portfolio.
Don't compromise your goals for some quick gains
We often make a mistake of either investing without a defined time horizon or assigning our investments to certain specific goals. Hence, we often lose sight of our goals when we spot an opportunity to make a quick buck. For example, in a current market like situation, one can get tempted to invest even short money into equity and equity related instruments. Needless to say, if the market turns volatile, one would find it difficult to stay invested and hence may end up either losing a part of one's investments or earning low returns. Therefore, the right strategy to achieve investment success would be to keep your focus on your goals and honour the time commitment for each of your goals.
Don't over-diversify your portfolio
While maintaining diversification in your portfolio as an integral part of the achieving investment success, it is also an aspect where investors often err. The general belief is that more number of funds one invests in, the more diversified portfolio would be. One often comes across portfolios where an amount as low as Rs 5,000 is invested through SIP [systematic investment plan] in five funds.
Remember, mutual funds are a diversified investment vehicle and having a number of similar funds can harm the portfolio in more than one ways rather than adding any value to it. For example, while having a quality mid-cap fund can help improve your overall portfolio returns, investing in too many mid-cap funds would invariably make you compromise on the quality of the portfolio as stock picking and sound investment process are major differentiators for these funds. Considering that mid-cap segment suffers from poor liquidity and limited coverage, it is always prudent to opt for a mid-cap fund or two that not only have quality portfolios but also an established performance track record.
While there is nothing like an optimal number of funds that you need to own to have a sufficiently diverse portfolio, factors such as the size of your portfolio and your asset allocation can help you decide the optimal number. For example, the debt part of the portfolio may require you to invest in more funds as the key is to manage credit and duration risk. To do so successfully, you will have to invest in different funds suitable for different time horizons.
Don't be obsessed with past performance
Although past performance is an important aspect in the decision-making process, relying too much on it can jeopardise your financial future. Even while considering the past performance, you must focus on long-term performance rather than the short term one.
Mutual funds offer a variety of equity funds, i.e., multi-cap, large cap, mid-cap, sector, thematic and those that follow an aggressive investment strategy such as opportunity and value funds. As we know, different segments of the stock markets behave differently over different time periods. For example, in the current market scenario, you will find either mid-cap funds or funds having higher exposure to mid-cap stocks, sector and thematic funds dominating the list of top performing funds. A strategy of investing in top performing funds now could result in your portfolio becoming too aggressive for your liking and that can be disastrous in the long run.
Similarly, a performance analysis of equity and equity-oriented funds during the periods of market downturns would project a disappointing picture. Relying on the past performance alone would compel you to stay away from equities during the periods best suited for making an investment. Besides, a conservative approach will create a gap between what you will need and what you may accumulate in future. Hence, you must look beyond past performance to make sound investment decisions.
Don't ignore time diversification
Time diversification, i.e., remaining invested over different market cycles is another factor that requires your attention. It helps in mitigating the risks that you might encounter while entering or exiting a particular investment or category during difficult times in the economic cycle. Remember, longer time periods minimise the impact of these fluctuations.
In fact, time diversification is also important for the debt part of the portfolio. While investing in ultra short-term debt funds, short-term debt funds and fixed maturity plans (FMPs) is fairly straight forward, investing in medium to long-term income funds, especially those that rely on duration play, can be a little tricky. It is important to know that interest rates and bond prices have an inverse relationship. When the interest rates start falling, the market adjusts bond prices to increase the interest rate yields, i.e., their price rise.
Of course, income funds following the duration strategy are ideally suited to investors who don't mind taking risk to earn a few percentage points higher returns. Here too, as has been seen in the past, many investors wait for the performance numbers to improve before taking the plunge. Many a times, they enter at the fag-end of the rally in the bond prices and hence not only miss out on an opportunity to make decent returns but also risk a part of their capital.
As is evident, you need to look beyond the past performance to benefit from the true potential of different asset classes. A combination of factors such as suitability of investment options in the portfolio, following a disciplined approach to investing and staying committed to your time horizon can work wonders for your investments in the long run.