Our thoughts are often clouted by perceptions or myths about people, places or things. Just because of our perceptions we miss a lot of good things in life.
Our perceptions are capable of swaying our decision-making ability, including our investment decision making. In the latter case, there is generally a cost attached. Investors’ myths manipulate their investing approach to sometimes too aggressive or too conservative or may keep the investor from investing altogether. Because of our perceptions & beliefs, we do not realize the full potential of our investment.
In the following passage, we have listed some common myths or mental traps which keep the investor away from being a successful investor:
- Investing in a large number of funds help:
As they say, “Don’t put all your eggs in one basket”, many investors tend to take the phrase too seriously. People believe that by spreading their investment amount across a large number of mutual fund schemes, above 15-20 schemes at times, they have a diversified portfolio, and this strategy will work as a hedge against probable risk from the bad funds, and will therefore aid in improving overall returns. It is true that diversification works to alleviate the risk, but then there is a disclaimer attached, an “optimum level of diversification” boosts returns by cutting risk.
Overdiversification, in fact leads to returns’ dilution, the below average returns of the last ones in line will offset the extraordinary returns from the top performing funds. And moreover, a mutual fund is already a ‘diversified portfolio’ of stocks and securities, so you do not need to diversify too much or carry every other top performing scheme in your portfolio.
- I can achieve all my dreams by investing in Fixed Deposits:
A vast majority of Indians invest in fixed deposits and other traditional fixed income generating instruments for their long term goals. An FD for kids education, an FD for kids wedding, a PPF account for surviving all your retirement years; despite the low rates of interest. The internet is flooded with literature on the scanty interest rates offered by fixed income instruments, and then if you factor in inflation to the already low return and subsequently the tax impact, the net return to the investors is so small that it may wreck the investors’ goals altogether. People invest in these products because of the safety of principal and guaranteed returns. But practically, the traditional fixed income investments are just safe, they aren’t good enough to create wealth and fulfill your dreams. For the latter, you must invest in Equity.
- Equity is Risky today:
There is also a set of investors who acknowledge the return potential of Equity, who believe that equity can help them in achieving their life goals. However, they keep on procrastinating their investing decision as they believe Equity is Risky “at the moment”. When you are investing for your long term goals, think from a long term perspective, do not get carried away by short term market trends.
- Timing the market helps improve returns:
It is true that market volatility plays a vital role in the growth of a stock or a mutual fund, investments made at lows of market cycles, may slightly fare better over the long term. But the irony is, no one really knows whether they are at the peak or the bottom, or lingering somewhere in between. There is no formula developed yet to measure or predict that status or the direction of the volatility. Yet there is an urge to trying to ascertain the “trend” and invest and withdraw accordingly. Surprisingly, this phenomenon is even witnessed in SIP investments, when the markets reach a particular level, some investors do think of stopping their SIPs with the view to resume investing later, defeating the essence of SIP itself. These investors suffer because:
They do not get the full benefit of Rupee Cost Averaging. Since the success of SIP model is based on averaging the cost by purchasing at lows, the investors who keep stopping and resuming their SIP’s often miss out the best purchase periods. Missing SIP installments translates to lower overall investment and so it may hamper the goal linked to the SIP.
- Past returns are the best indicators of the quality of the fund:
Investors often look at the historical return stats of Mutual Funds and choose on the basis of a performance comparison alone. Past returns do offer a perspective into the fund’s quality, but it isn’t the sole indicator, there are a number of other factors that go into the equation, like possible downside risk, consistency, fund manager’s tenure, whether the scheme would be a good fit for your goals and investment horizon, etc. Moreover, it may have been the best or the worst performance period of a particular scheme. Hence, it may not be correct to associate a fund’s potential on the basis of past return numbers only, because if this were the case, every financial advisor and investor would have been investing in the same scheme, and everyone would be a crorepati. But we all know, it won’t work this way, so it’s ideal that you seek help from your financial advisor, and jointly consider all the elements auxiliary to your unique investment profile before taking a decision.
- Active changing / switching between funds help returns:
Many investors believe that by churning their Portfolio, they would be able to boost the overall returns. While it is a good practice to periodically review the Portfolio and base your investment or divestment decisions on the basis of thorough research.
These decisions must be taken in line with your long term goals, or to eliminate consistent underperformers, or on the happening of certain events like your son is in class XII and soon you’ll be needing money for his higher education, so it’s ideal that you switch the investment made for this goal from Equity to may be a Liquid Fund to avoid the impact of short term volatility on the investment. However, there are various instances when investors switch, out of impulse rather than for any of the above, like if one of the investments isn’t returning as much returns as the investor was hoping for, or there is a new product launched and there is an urge to switch the investment with this product, or because other people have made money in a stock or a scheme and the investor too is tempted to make big bucks from that scheme by cashing out his existing investment. Such decisions can play havoc in the investor’s portfolio, he may have replaced a scheme which was linked to an important goal with another scheme which is a misfit for his risk profile and investment horizon, these decisions can sabotage his/her long term investment plan and goals. So, the bottomline is, investors’ investing judgment is often planted on their beliefs, it’s their psychology which is the real reason behind their investing failures. The above myths are a few among the many mental traps which you can succumb to.
Therefore, it is vital to have a neutral mindset while taking an investing decision. Having said that, for an investor it is not easy to keep his perceptions and investing judgment separate, primarily because of his attachment to his money, in his efforts to bring the best upon himself, he goes astray. So, it’s highly recommended to seek professional help, because a professional’s psyche on investing will be rule based and not perception based.
When it’s about movies or food or lifestyle, you can afford to ruin an evening, but when it’s about finances, you better be careful.
