Wise people learn from their own mistakes while wiser ones learn from others’ mistakes. However, as making mistakes while investing will cost you both money and time required for creating wealth, the best approach is to try to avoid them, at least the most common ones, by learning from others’ mistakes.
I will discuss some of the most common investment mistakes that most retail investors commit at least once in their lifetime.
Mixing insurance with investment:
The main purpose of buying a life insurance policy is to ensure replacement income for your family in the event of your unfortunate demise. Term insurance plan is the best product to get adequate life cover as it can buy you the ideal cover of 10-15 times of your annual income at very low premiums. For instance, a 30-year term plan cover of Rs 1 crore for a 30 year old would cost an annual premium of just around Rs 8,000-12,000. However, most investors mix up insurance and investment by investing in ULIPs, endowment or money back policies. These products neither generate optimal returns nor provide adequate cover. These insurance policies also have a lock-in period of 5 years with some like pension plans remaining locked till the age of retirement.
You must avoid mixing insurance with investment. Mutual funds are best suited for long-term wealth accumulation due to their greater scope of generating higher returns, higher liquidity and greater product diversity to suit varying risk appetites. For example, ELSS, a tax-saving mutual funds category, has a lock-in period of just 3 years, which is the lowest amongst all tax-saving instruments under Section 80C.
Investing without identifying financial goals:
Financial goals are monetary value of your life goals – aims that you wish to achieve in your life. Setting financial goals will give you a clear idea of how much to save and invest regularly to meet your life goals. Identifying financial goals also help in achieving a better asset allocation based on your risk appetite and time horizon. For example, as equities can be very volatile in the short term while outperforming other asset classes over the long term, investments for your long term financial goals should be made in equity related instruments for generating bigger corpus.
A sizeable section of investors fail to take into consideration the impact of inflation on their investment corpuses. By reducing the purchasing power of money, inflation can land you with inadequate financial corpuses. Goods or services worth Rs 100 now will cost Rs 146 after 5 years assuming an inflation rate of 8 per cent. After 30 years, that same goods or services will cost over Rs 1,000. Hence, while calculating the ballpark amount of your financial goals, inflate their current value by at least 10% p.a. to be on the safer side. To ensure the creation of adequate corpus for your long-term financial goals, invest your contribution in the time-tested inflation-beating asset class of equities.
Not maintaining adequate emergency fund:
The main objective of this fund is to cover your mandatory monthly expenses for at least 6 months, in case you stop earning due to job loss, ailments or other unforeseen event. Without an inadequate emergency fund in place, an unforeseen financial exigency may force you to redeem your long-term investments. The damage can be greater if such exigencies occur during market corrections, thereby forcing you redeem your long term investments at loss. Hence, set aside adequate emergency corpus to meet your financial needs during emergency situations.
Getting carried away by emotions:
Investors are often swayed by the twin emotions of fear and greed during their investment decision-making. The emotion of greed leads them to increase their investments during bull market conditions when high valuations should instead worry them. The emotion of fear leads them to redeem their existing investments or stop making additional investments during market corrections when equities are actually available at attractive valuations.
Instead of clouding your rational decision making owing to these emotions, invest in mutual funds through SIPs to ensure disciplined investing. As SIPs ensure regular investing, it allows you to benefit from rupee cost averaging --- buying units at lower NAVs during market dips. Also create ‘market-crash fund’ to invest lumpsum in equity funds during steep market corrections. Doing these will allow you to make the most from lower valuations and achieve financial goals faster with lower contributions.
Factoring recent performance during fund selection:
Many investors compare the funds’ recent performances, especially their last 1-year returns, while selecting funds. However, such short-term under- or outperformance can be temporary in nature. Even good funds with glorious past track records can underperform due to their fund management style and prevailing market conditions. Thus, while selecting your equity mutual fund, compare its past performance with its benchmark indices and peer funds for the last 5-year and preferably 10-year period. A 10-year period comparison will give you a clear idea about the fund’s performance over an entire economic cycle.
By Naveen Kukreja, CEO & Co-founder, Paisabazaar.com...