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8 mistakes you should avoid for being a wise investor - Outside View by PersonalFN

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8 mistakes you should avoid for being a wise investor
Jun 30, 2014

The NDA Government recently completed a month in office. Taking this opportunity to communicate with people, Prime Minister Mr Narendra Modi made a statement that, "every new Government has something that friends in the media like to call a 'honeymoon period.' Previous Governments had the luxury of extending this 'honeymoon period' upto a hundred days and even beyond. Not unexpectedly I don't have any such luxury."

And possibly sniffing this progressive attitude of Mr Narendra Modi and ascertaining that he's a task master, the Indian equity markets are showing signs of being on a honeymoon. The market rally that started in September last year, got accelerated in February and is further boosted after a stable Government was formed in May, although there are several challenges before this Government. Inflation is quite high upside risks to inflation are even higher. Global events such as Iraq crisis are throwing up new challenges, etc. In fact, the comments of the Prime Minister just point at them. Despite that, markets are confident. Amidst this, markets are holding up strong near their all-time highs. Retail investors who refrained from investing for nearly 5 years, have suddenly started flocking way to equity markets. So, many of them who resisted to invest in equities and missed the bus as the markets moved all the way up, are now hopeful that the market still have some further steam left.

You see, with the year-end targets of the S&P BSE being revised upwards and much hopes evinced on Mr Narendra Modi to revive economic growth and to build Brand India, there is exuberance filled in the markets. And amid such times, investors usually show some traits. PersonalFN here discusses eight such traits, which you should clearly avoid as it affects your investments.

  1. Anchoring:

    While investing, often investors take decisions based on irrelevant statistics and numbers. For example, an investor who invested in a sector fund at the peak, lost money subsequently when downturn started. He kept holding onto his investments thinking that one day his investments would break-even. You see, his buying price is irrelevant. What is relevant here is the movement of underlying sector. Investors tend to lose money if they anchor to investments on hopes of a recovery one fine day as the markets ascend. .

  2. Mental Accounting:

    Often in a fast moving market, investors engage in mental accounting and often tend to speculate a lot. But one needs to recognise that, speculating can be hazardous to your wealth and health Often when investors earn money from speculating, they tend to engage more in it, as they perceive that even if a loss does occur, at the most the profits would be eroded. But this thought itself is fundamentally flawed and if investing is done on this premise, it can turn damaging to your long-term financial well-being. If you invest wisely, giving due thought to fundamentals and valuations you can indeed grow your wealth by investing in equities in the long-term.

  3. Getting carried away:

    This limits your abilities to merit the view that is contrary to yours. For example, if you have always been an investor in large caps in accordance to your risk, but now suddenly with a spurt shown by mid & small cap domain you tend to get carried away; you are developing a trait of being carried away and deviating from what actually suits you. In such a case, there is a possibility that you are reading only good news about the midcap section hoping that your funds will do well going forward, but aren't really recognising the very high risk commanded by mid and small caps. Remember, it vital to go by what is prudent and what suits you.

  4. Heard behaviour:

    A few people blindly follow other investors and invest in stocks and mutual funds. They don't mind selling a stock which is being sold by majority of investors and they buy when stock turns hot and it is in great demand. The same is true in case of mutual funds. Since others are buying a thematic fund, you would also buy a thematic fund, if you follow the momentum.

  5. Overconfidence:

    Over confidence is the biggest enemy of an investor. A few investors believe that they can pick stocks and mutual funds flawlessly. They believe they can predict market direction and thus take aggressive call. Betting only on a few stocks or sectors without adequately diversifying portfolio is another indicator of over confidence. There is risk of going wrong for some reasons which are not known to you at the time of investing.

  6. Gambler's fallacy:

    Some investors, who indulge in trading in stock markets rather than investing, believe that they know the markets well, when they get their bets right numerous times. They exhibit gambler's fallacy and are overconfident about their abilities. But remember, a trader is only good until his last trade. You can never say, when a trade can show it nasty side.

  7. Over-reaction and availability bias:

    It is not totally uncommon to see stock markets rising or declining by 3%-to 4% in a day. On many occasions, investors overreact to a new development. Best example is dramatic fall that happened on May 18, 2006. S&P BSE Sensex lost -6.76% in a day on the news that the Government may impose a higher tax on foreign investors. Before further clarification on the matter could come from the Government, markets had already taken a beating. Although there was no problem with Indian economy, markets declined. This shows overreaction and heard behaviour are interlinked and in a combination may hamper progress of your investments. Focusing only latest news and following latest trend is equally bad.

  8. Prospect philosophy:

    Losses are remembered for long, while profits earned can easily be forgotten. You see, there is more emotional value attached to losses than to profits. One may continue holding a poorly performing mutual fund for very long while may quickly get out of a profit making fund. Closer understanding of prospect philosophy suggests that it is somewhere linked to the concept of anchoring.

PersonalFN is of the view that, it is important to be a responsible investor than merely assimilate such traits in you as an investor. Those who can overcome above discussed traits and follow a disciplined approach to investing may do a lot better. Generating attractive returns on investments may not be a rocket science but following certain sound investment practices may safeguard your interest. PersonalFN believes commission oriented nature of investment advisory business in India and unscrupulous practices followed by agents and brokers of financial products have nurtured the above mentioned traits. Rather than avoiding equity markets and holding back from investing in mutual funds, investors should avoid these 8 mistakes.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "8 mistakes you should avoid for being a wise investor"

Ashok

Jul 2, 2014

The mental acctg expl is not very clear.

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