Whether you are investing to build a retirement fund, or to put your excess cash to work, you should always be wary of the following investment mistakes. These can ensnare an experienced investor as easily as they can entrap a rookie. Here are 10 investing mistakes to watch out for:
1. Investing while in debt.
The phrase “cheap debt” is thrown around
by the financial experts routinely. However, it does not apply to credit cards.
To invest money when one is living off credit cards is a big no-no. One should
repay credit card debt as soon as possible.
Similarly, putting money aside for
investment while having a student loan or a house mortgage might seem
like a good idea, as the expected rate of return on the investment is higher
than the expected cost of debt. However, the comparison is incorrect. Today’s
cost of debt is being compared to tomorrow’s rate of return. We are coming out
of the zero interest rate period, and it is not unreasonable to believe that
debt will become expensive again over time. One should prioritize offloading all
debt before one starts setting aside money for investments.
2. Investing with a very high cost of
transaction.
When one buys or sells investments, one
invariably coughs up fees and charges. In some cases, the cost of a transaction
is quite high. When investing in a house, for example, be sure that you do not
liquefy the investment within five to seven years. If you sell the house within
that time frame, then the transaction costs will substantially eat into your
rate of return.
Another avenue in which the costs are
very high is investment in physical gold. Apart from the transactional costs of
gold, one should account for the charges applicable for its safe and secure
storage. It is more advisable to invest in gold ETFs instead of
physical gold.
3. Investing with a single-minded focus
on fund fees.
The internet is full of advice on
choosing low-cost funds instead of paying a premium on funds managed by
rock-star fund managers. Undoubtedly, a lot of advice is sound, but some
investors make decisions purely based on fund fees while being ignorant to
other parameters like the rate of returns they deliver, or the amount of asset
diversification they have. In some cases fund houses use “cheap funds” as a
marketing ploy. In Britain, HSBC’s Equity Tracker Fund has an expense ratio of
0.27% a year, while Virgin’s equivalent equity fund charges a full percentage
point extra. However, both the funds are being heralded as low-cost funds by
their respective fund houses.
4. Investing in hot tips.
Hot tips and fads rule the market, and
just about everyone is an expert on the Next Big Thing. However, such advice
should be taken with a grain of salt. Investment is a process, and due research
is a necessary aspect of this process. After all, if you are not willing to put
in the time and effort necessary when making an investment, you can’t expect
your investment to reward you with your returns.
5. Investing decisions based on market
conditions.
Market conditions cannot dictate one’s
investment strategy. The inherent volatility in the market is
frustrating, especially when investment portfolios underperform the
benchmark index. Doubts start creeping into one’s investment strategy. However,
investment strategies cannot change with the market cycles. It is imperative to
have faith in one’s strategy, provided it is based on sound characteristics. A
good strategy with a long-term outlook may under perform for a period of several
months based on the market conditions, but in the long run it will reap the
desired rewards.
6. Investing while overpaying for
investment services and financial planners.
There are multiple avenues for investing
one’s hard-earned money. To understand all the options out there you may need
assistance, and that is where financial advisers come to our aid. However, when
a financial adviser builds a portfolio of low-cost index ETFs, then one wonders
if there is any value to the adviser. The cost advantage of investing in a
cheap ETF is consumed by the fees of the adviser. Some advisers even receive
hefty commissions for recommending investment products. If that is the case
then the financial adviser’s motives will not match your interests. One should
be wary of such advisers.
7. Investing on margin.
No matter how enticing an opportunity,
one shouldn’t buy stocks or investments on margin. Margin trading has its
benefits, but those should be left to the professionals. If the investment is
leveraged, then one bad trade can wipe out a significant chunk of one’s
investments and set one back significantly. In addition, when investing in
property that is not for personal use but for investment, using housing loans
is not a good strategy. The recent housing crisis points to the flaws of such
leveraged investing. Bottom line: always invest with money that you have and
can afford to lose without any adverse impact to your financial health.
8. Investing with an unrealistic
expectation of return.
Investing with an unrealistic
expectation of return, and without accounting for the compounding magic of
time, is a strategy that is doomed to fail. In pursuit of manifold returns,
people dabble in the penny stock market and end up burning their hard-earned
money. In the end, if an investment idea sounds too good to be true, then it
probably is.
9. Investing out of fear and greed.
Emotions are attached to one’s
investment decisions. We all feel joy when an idea works out to our benefit,
and all feel despair when a decision goes bad. However, the emotions of greed
and fear should not override one’s sense of logic and reason. Greed and failure
prevent one from making smart decisions; they make one follow the herd
mentality instead.
10. Investing without a plan.
Investing is a boring process. To see
meaningful returns, one needs time to do its magic. Patience is key. An
investment plan, revolving around meaningful financial goals, helps when things
get rough. It provides motivation to save money when the same money could
easily be spent on mundane activities. It provides the focus and determination
required to pursue a life of financial independence.
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