Common Equity Investing Mistakes
With the new NDA government coming to power, many investment experts believe that India is on the threshold of a long term secular bull market. While it is certainly easier to make money in bull markets, it is also easy to make mistakes in bull markets. Mistakes cost investors money and therefore must be avoided. We should clarify that this article is addressed to investors. Here are eight common equity investing mistakes in bull markets.
1. Trying to time investments at the start of a bull market: Retail investors wait too long trying to time the market. Most retail investors are not able to spot a bull market when it is taking off. When the market runs up significantly, retail investors realize that they have missed the bus. Timing the market is incredibly difficult. Even experienced professional investors often do not get their timing correct. Equity investing should be goal based, not timing based. Set investment goals and invest for the long term. Timing does not matter if you have a long time horizon.
2. Ignoring asset allocation: In bull markets hot stocks and mutual funds are always in news. It is important to select great stocks or mutual funds to get higher returns. But investors do not realize that a much bigger portion of portfolio return is attributable to asset allocation and only small portion of returns can be attributed to stock or fund selection. For example, even if you select a great mutual fund that gives you 25% compounded annual returns, if 90% of your portfolio is invested in fixed income assets yielding 6% post tax returns, your overall portfolio returns is less than 7%. You should pay more attention to your asset allocation and consult with your financial adviser to get appropriate guidance on the right asset allocation mix.
3. Adopting trading strategies in bull markets: Investors should understand the difference between trading and investing. Traders are usually professionals and aim to generate profit over a short time horizon, ranging from a day to a few weeks. Investors, on the other hand, aim to create wealth by investing over a long time horizon. Trading and investing require very different strategies. Retail investors in bull markets, seeing market rise sharply, switch to trading strategies. Investors may even be able to make decent intraday or positional trading profits in bull markets. But investors should not think that they are expert traders just because they have made trading profits. Trading is extremely technical in nature and requires considerable expertise and experience which most retail investors do not have. Investors should especially avoid taking leveraged positions using derivatives like futures and options because they can incur big financial losses, if the market or the stock moves in the opposite direction of their trade.
4. Blindly investing in hot midcap tips: Midcap stocks get beaten more than large cap stocks in bear markets. Consequently some of these stocks rally sharply in bull markets, when valuations of large cap stocks seem stretched. Often in bull market rallies, midcap stocks outperform large cap stocks. But in case of a lot of midcap scrips, the up moves are essentially momentum moves and not backed by strong fundamentals. Picking quality midcap stocks requires considerable skills and experience. If you are not an expert stock picker, it is always advisable to invest in midcap funds instead of directly buying midcap stocks.
5. Paying too much attention to monthly economic data: The media goes on overdrive over daily, monthly or quarterly economic data, be it exchange rate, index of industrial production (IIP), inflation statistics, CRR, repo rate etc. It is true that the market reacts to these numbers. But they are not relevant for long term investors. You should stick to your investment strategy and not react to these numbers. The best investment strategy is to get your asset allocation right, and invest in high quality stocks or mutual funds with great track record, and let their investment compound.
6. Panicking in sharp corrections: In a bull market, stock prices rise sharply but they can also fall sharply. In a secular bull market, sometimes these corrections are prolonged and may last several days or weeks. Investors, who cannot handle volatility, cash out during market corrections. But by cashing out during bull market corrections, investors are compromising on their long term financial goals. Investors should remember that such corrections are always of shorter duration than the periods during which the market rise. Over the last 20 years, the market went through many sharp corrections and yet the Sensex is many times higher. Therefore investors should stay invested through the periods of volatility. Their investments will grow in value once the uptrend resumes.
7. Turning off SIPs during a downturn: Successful investors have made money in the market by buying stocks when everyone else was selling. Retail investors often find it difficult to handle volatile markets and stop the Systematic Investment Plan payments during a market downturn. This is a mistake. SIPs enable the investors to buy equities at a low cost in market downturns. SIPs work on the principle of “Rupee cost averaging”. By investing a fixed amount, every month or at any other regular frequency you can buy more units when the prices are low and less units when the prices are high. SIPs ensure good return on your investment and help you meet your long term investment objectives.
8. Hanging on to underperforming stocks or funds: While investors should have a long time horizon for their investment, they should make sure that they do not hang on to underperforming stocks or funds. Even if the investors have performed adequate diligence in selecting stocks or funds, it is possible that some stocks or funds may not perform well. Retail investors often hang on to underperforming stocks or funds, especially if they are making losses in these stocks or funds. Sometime investors buy additional units of underperforming stocks or funds, to average the purchase cost or NAV. While this strategy may sometimes work in trading, this is a wrong investing strategy. Investors should monitor their investments on a regular basis. If there are stocks or funds in your portfolio which are underperforming relative to the benchmark for 2 – 3 years, then you should exit from these stocks or funds, and switch to stocks or funds that have been performing well. Even if this entails booking losses, investors should not hesitate in exiting underperforming stocks or funds
Investors should avoid these common mistakes when investing in equities. Equities are essentially long term investments. By selecting good stocks or mutual funds, and remaining invested in them over a long period of time, investors can create wealth in the long term by leveraging benefits of compounding. There is always a lot of surround sound in the media with regards to equity markets. Investors should cancel the noise in the surround sound and stick to a disciplined approach to investing.
(Source: Dwaipayan Bose, www.advisorkhoj.com, 28 May 2014)