7 Investing Mistakes to be avoided by Young Investors
7 Investing blunders to be kept at arm’s length by Young Investors:
Most of the young investors who enter the financial markets want a quick return on investment and instant gratification of their investment motives. This tendency of “Right Here Right Now” makes them lose a long-term perspective and commit some serious investment mistakes.
I am listing out 7 mistakes that you as an investor should avoid while you embark on your investment journey.
Christopher Parker once said that “Procrastination is like a credit card: it’s a lot of fun until you get the bill.”
The first mistake that almost every investor does is procrastination. Research conducted at Harvard found that human beings have a tendency to undervalue long-term costs and overvalue the immediate benefits of procrastination. You may prefer to buy a costly mobile phone with your first salary than create an investment account with the same amount. It’s so because at present you are unable to visualise the long-term benefits of a big retirement corpus that would be built out of such disciplined savings.
Your accomplishment of a financial goal is dependent on two factors i.e. duration of investment and amount of investment. The longer your money remains invested, the more returns it would accumulate. Let me quantify procrastination for you, Anita and Shilpa want to retire at the age of 60. Anita starts investing Rs. 2000 pm for her retirement starting at the age of 30 while Shilpa delays the activity till the age of 45 but investing 4000 per month. Even though Anita contributes a smaller amount as compared to Shilpa, she would end up with a bigger retirement corpus of Rs 38.4 Lakh, which is 4 times more than the amount that of Shilpa. This happens because of the power of compounding.
Thus, each day postponed would require more money to build the same amount of corpus to achieve financial goals.
Also read: Power of Compounding
2. Risk aversion instead of Risk-seeking
Risk aversion can reduce your chances of accomplishing your financial life goals. Young investors usually have the ability to take higher risks as they have time on their side as well as the possibility of income increment in the long term, but its lack of financial awareness and literacy that influences their risk perception, who tend to invest more in low yielding fixed income instruments like FDs, NSC, bonds etc. You should understand that such instruments provide you only assured returns at the cost of wealth creation. A fixed deposit at 7.5% interest rate gives you a negative real rate of return after taking taxes and inflation (5.7%) into consideration.
Thus, keep in mind that saving takes care of only short-term monetary needs while Investment in long-term instruments like equity, helps in wealth maximisation and gives a positive real rate of return. While Insurance is for covering life, health and property risks.
Also read: Inflation and the Real rate of return
3. Ad-hoc Investing without a Plan
This is a classic investing mistake; believe me, this can do more harm than good to your finances. In Yogi Berra’s words “If you don’t know where you are going, you’ll end up someplace else.”
The above is true when ever you do the last minute tax saving exercise to meet the deadlines given by your HR. Adhoc investing also happens when you don’t have a plan, and a friend or relative of yours makes you a part of their plan by selling you financial products that are in line with their financial objectives.
If you also invest in financial products succumbing to coercion from friends or family or to fulfill immediate tax-saving needs, your probability to digress from personal financial planning goals increases. Ultimately your money gets blocked in unproductive investments.
Before investing try to find out risk-return-liquidity implications of such products. Make sure it contributes towards the accomplishment of your financial goals.
4. Bandwagon Effect
Under Bandwagon Effect, you will feel left out if you are not participating in markets that are skyrocketing. Hence you will become a part of irrational exuberance by investing your funds in those investment plans wherein a majority of young investors put their money. Because of the emotional turbulence, you do not investigate the investment plan to gain a deeper insight. You ignore your personal financial goals, the state of the economy, the real worth of investment, and financial repercussions of such an imitation. You refuse to believe that “How so many people could go wrong in their investment decision?”. You are afraid to go against the flow. Like the majority of investors, you also consider those plans as sound. This kind of investor behavior leads to the formation of a bubble in the financial market.
But remember my friend; such bubble could burst sooner or later. Consequently, you burn your fingers and your portfolio returns tank.To dive into the ocean of financial market without ample research at hand could be a self-destructive act. In fact, one who goes by logic and facts would be able to steer his boat in the midst of media hype and enthusiasm from all quarters.
5. Not Stepping-up your Investments
“Your cow cannot give you more milk unless you feed her more fodder.” Investments demand the similar commitment from your end. Owing to ever-rising inflation, the same amount of investment continued for a fairly long period of time would not fetch you ample corpus to fulfill your financial goal.
It is said that an ideal saving to income ratio should be maintained at all times. It means that as your income grows, you should increase your level of savings as well. Saving rate is the amount of money that you take out of personal disposable income and invest in financial products.
Suppose you earn a monthly salary of Rs. 1 Lakh and contribute 30% of your salary i.e. Rs 30,000 towards a Systematic Investment Plan. Next year you get an increment, and your monthly salary grows to Rs. 1.5 Lakh. Accordingly, you need to step-up your investment by Rs. 15,000 and contribute an amount of Rs. 45,000 towards your SIP. In this way, you need to maintain a desirable saving to income ratio and keep increasing your savings rate with an increase in your income.
6. Falling prey to Ponzi schemes
Time and again people fall prey to Ponzi schemes. These are collective investment schemes which promise to give you sky-high returns in a short span of time. It pays returns to existing investors out of money collected from new investors instead of paying out of profits. The Speak Asia scam, which rendered many investors speechless is a classic example. Not to forget the recent Saradha Chit Fund Scam, Sahara Scam, etc. In India, it is estimated that these schemes managed to collect more than Rs 66,895 crore of investments by duping millions of investors.
Because of greed and in a hurry to make easy money in a short span of time, you may consider putting whole life savings in these schemes. Don’t let the greed take the central stage in your investment decisions. Beware of such schemes. Do look for the warning signs before you invest your money.
7. Putting all your eggs in the same basket
I am sure this adage applies to investing the most. Investing all your savings in one asset class can prove to be hazardous to your portfolio. A portfolio which is completely skewed towards one asset class or having a single asset class will have the highest risk.
An asset class is a bundle of securities that behave in a similar fashion in the market, offer identical returns and subject to same regulations. When you stick to only one asset class like equities or bonds, then your probability of loss increases if the prices of the underlying securities tank. This is a case of lack of diversification of investments.
Further to diversification, lack of rebalancing also makes you lose on account of deviated risk exposure. Suppose your initial asset allocation in the beginning of the year was 70:30 on equity and bonds. As the stock markets grew in the subsequent year, the ratio changed to 80:20 which made risk exposure to exceed your target asset allocation. To ensure desired risk exposure, you need to sell some stocks and buy some bonds to bring back the ratio to 70/30.
Hence, it is advisable that you diversify and rebalance the portfolio to conform it to your risk preferences and financial goals.
William A Ward, one of the most quoted American writers, once said “Before you spend, earn. Before you invest, investigate.”
Small mistakes at the time of investments may cost you big. Crowd mentality may lead you away from your financial goals. Ponzi schemes which promise to provide quick money in a short time only inflicts financial sufferings. Therefore, be vigilant, composed, and informed when you enter the financial market. Get up and get going. Start saving, invest carefully and retire rich.