As human beings we make mistakes. The scope of such mistakes extend to investment decisions as well. Retail investors, who are usually not trained to take financial and investment decisions, are prone to making mistakes which could be analytical as well as psychological in nature. According to financial planners, mistakes that retail investors make with their investments could primarily be categorised into three types: Those based on emotions rather than logic, those because of peer pressure and demonstration effect, and lastly investors’ belief that a simple investment solution can not be the best solution.
As an investor you should know these common mistakes so that you can consciously avoid them during your investing life.
Decisions backed by emotions
Often retail investors, in experienced about investments, often make a decision based on emotions rather than sound logic. For example, owning a house is often considered as a symbol of financial success, even if such ownership comes with a major loan burden which can cripple the buyer financially for several years.
At times investors also get emotional about some particular asset class because of legacy issues like his/her father had invested in that particular asset all his life. At times such decisions are also influenced by recent historical reasons. Such decisions skew the asset allocation process and turns out to be a hindrance to the financial planning process, financial planners say. For example if an investor finds that gold has given very good return over a five year period, and at a multi-year peak, he/she may get tempted to invest heavily in gold. On the contrary in such a situation a prudent assumption would be that gold should underperform other assets classes in the next few years and so once should invest less in yellow metal.
Demonstration effect & peer pressure
Often it happens that someone’s friend or neighbour had a windfall on some investment, which for all practical purpose was due to luck than efficiency. However, his/her friends and neighbours try to replicate the same success by investing in a similar fashion, and in most cases fail.
Another influential factor for investors to forgo logic while investing is peer pressure. Often this is seen when a group of people takes an investment decision, which influences another closely associated person to take the same decision even though that particular person’s risk taking ability and investment needs may be very different from the other members of the group. This could happen within the family, office, club, locality etc.
Ignoring simplicity for complexity
Most seasoned investment managers prefer a ‘keep it simple, keep it stupid’ approach to constructing a portfolio which eventually comes out to be a winning one. However, a large number of investors think that a portfolio with a complex structure is better than a plain vanilla one. Like seasoned investment managers, experienced financial planners and advisers prefer to construct a portfolio for their investors which the investors themselves also understand. A simple portfolio would probably consist of debt and equity mutual fund schemes, gold ETFs, term plans and FDs. In comparison a complex portfolio will probably have lots of derivative products, structured products on real estate but very less of mutual fund schemes and gold ETFs. Financial planners usually tell their clients to invest only in those products which they understand.