Behavioural Mistakes To Avoid While Investing

It’s often said that an investor’s worst enemy is he himself. If our house is on fire, we listen to our intuition and run for safety. This helps us survive. However, in the case of investment decisions, this behaviour can land us in trouble. The moment we see signs of panic in the stock market, we run to sell all our stocks; when we see euphoria, we jump into the market. We tend to behave irrationally and in a biased manner in many investment situations. 

Our long-term investment success is determined by our ability to control our‘inner demons’ and ‘psychological traps’. The good news is that human behaviour is irrational in a predictive manner, as examined by Professor Dan Ariely in his book ‘Predictably Irrational’. Once we recognise these ‘inner demons’, we can develop approaches to tackle them. A thoughtful investor can leverage this predictable irrationality by remaining un-swayed by the noise and making rational decisions, thereby taking advantage of others’ ‘behavioural biases’. One of the inner demons is ‘over-confidence’. Time and again we tend to overrate our ability, knowledge and skill. Watching 24-hours news channels and listening to ‘experts’ we tend to believe that we are experts and make investment decisions that are not thought through. We think we can predict and time every up and down of daily price movements and invest accordingly. Overconfidence can lead to excessive trading and poor investment decisions. To be a successful investor, one needs to follow a zero-based approach towards decision-making. Investors need to be prudent to not sell their winners too soon and nor hold on to their losers too long.

Another important psychological trap we need to avoid is ‘herding’. People tend to follow the actions of a larger group, independent of their own knowledge. Large-scale social imitation can lead to significant gaps between actual value and price. This herd-like behaviour phenomenon can create profitable opportunities for an individual stock. But taking advantages of collective irrationality, either for a specific stock or for the market as a whole, is difficult. Since most of us have a strong urge to be part of the crowd, acting independently is not an easy feat.  However, if we’re able to control this behaviour, it can result in significant investment gain for us. Warren Buffet sums this up by saying: 

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”.

 It requires significant control over one’s emotions to practice in real life.  Focus on avoiding silly behavioural mistakes. Research has shown that behavioural mistakes can reduce the return on investments by 10% to 75%. So what do you need to do avoid this? It can be summarized in one word: discipline. One need not always focus on becoming smart. Avoiding silly behavioural mistakes can help one become a successful investor in the long-term. Warren Buffet once said, “You only have to do a very few things right in your life, so long as you don’t do too many things wrong”. If we can avoid making a big mistake, the right decisions would take care of themselves.  As the central theme of the Mahabharata, the battle for investment success is about systematic adherence to dharma – financial dharma. As stated in the epic, “The road to heaven is paved with bad intentions.” Our journey towards financial heaven is filled with inner demons, which need to be identified and tamed for long-term superior returns. Just as mental discipline and willingness are required to forego short-term pleasure to wake up every day and jog for good health, a similar discipline and willpower are required to follow the simple but powerful mantras of enhancing long-term financial health. 

 Key Takeaway Points • Always use a ‘checklist ‘approach towards entry/exit of stock. Keep it short and reasonable.  

• It is better to do your due diligence before investing. Keep a safety margin while ; never invest to lose.

• Adopt a ‘buy and hold’ strategy with periodic review.

• The less frequently you track the market and check your portfolio, the less likely you will be to react emotionally to the natural ups and downs of the stock market.

• Be more thoughtful while taking a long-term investment decision. Losing one day’s return will not matter if you want to keep the stock for 10 years. When you see a sign of panic or euphoria, the best advice would be to wait for another day. If the investment is meaningful from a long-term perspective, the opportunity will continue to remain a good one, even in the future.

• Have appropriate asset allocation, and rebalance your portfolio periodically.

• Be humble, and learn from your mistake. When you succeed, evaluate which of your actions contributed to the success, and which ones did not. Don’t claim the credit for successes that have occurred by chance. Avoid rationalisation when you fail.

• Don’t exaggerate the role of bad luck in your failures

Happy Investing!

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Various Investment Options

When you first start out to plan your finances, it is likely that you are overwhelmed with the options there are. There are a number of instruments that will help you grow your money, but how do you choose which ones are appropriate for your needs? We’ll give you a brief on the popular investment avenues and tips on how you can make your decision.

To understand this, the following will help you put investments in perspective. Investments are all split into “asset classes” – primarily these are equity, debt, gold, and real estate.

Equity refers to the stock markets. Debt refers to an investment that is linked to fixed returns for a particular maturity period.

Now, on to the main investment product options available and what they are:

PPF

Public Provident Fund (PPF) comes with a fixed interest rate for each year, which is pegged to prevailing government bond yields. With an upper limit of Rs.1,50,000 per year, it is meant to inculcate small saving habits. The investment amount is locked-in for 15 years and is eligible for tax saving deduction under 80C. Current rate of interest on PPF is 8% per annum. EPF is similar to PPF.

The positives: With a long lock-in period, PPF ensures that you put aside some money for the long term. Apart from being eligible for tax deductions, the interest on PPF is also tax-free.

The negatives: Being a debt product, its returns are limited and even investing the maximum amount each year may not be enough for your retirement corpus.2.

Fixed Deposits

FDs issued by banks are more common, but corporates issue FDs as well and often with higher interest rates. FDs have fixed maturity and can range from 7 days to even 10 years. A few bank FDs have become more flexible with premature exit options but largely they are locked in for the maturity period. Prevailing interest rates in popular banks is around 6.5%-7% per annum while the higher risk counterpart corporate deposits offer around 8.5%-9%.

The positives: FDs are low-risk, offering a guaranteed return. Setting up recurring deposits and using your bank’s sweep facilities are a great way to build up investments. FDs ensure that your money is not idling in savings account earning minimal interest.

The negatives: For longer time periods, FDs aren’t great. Historically, they haven’t given inflation beating returns. Interest income is also taxed at your tax slab. Depending on FDs alone for all your needs means you need to save up a high sum or you may miss your target.

Insurance

Insurance in its true sense is a risk cover. But some life insurance policies like endowment and money-back policies place themselves as investments. This is because they offer some benefits on maturity even on survival. ULIP is a hybrid product where a part of the amount gets invested and a part goes for the insurance cover. ULIPs have different schemes which invests in equity and debt market.

The positives: Insurance provides a protection. Premium payments qualify for tax deductions.

The negatives: They are not investments. Variants which give lumpsum amounts at the time of maturity may look attractive, but the returns are poor given the time you stayed invested. ULIPs give you a life cover and returns from your investment. Unfortunately, the life cover you get for the premium paid is minimal, when compared to plain term insurance. In a ULIP, you get neither adequate insurance nor investment. Liquidity, transparency, and comparisons of ULIPs are also poor.

National Pension Scheme (NPS)

NPS is a pension scheme which invests in a combination of equity, corporate bonds and government securities. You can decide the allocation between each yourself, or you can allow the system to choose it for you. The scheme matures when you turn 60 or 10 years from the time of account opening, whichever is earlier. At that time, up to 60% of the amount can be withdrawn and the rest is compulsorily invested in annuity. Even though premature withdrawal is possible for a certain amount, it comes with a lot of rigid clauses.

The positives: NPS gives an additional tax deduction of Rs.50,000 under 80CCD. Similar to PPF, the long lock-in period ensures that there is a retirement fund is in place. The addition of equity helps improve returns compared to PPF or EPF.

The negatives: For disciplined investors who don’t need such constraints, NPS is a bit too rigid. Compulsory conversion of a large portion of the end corpus into an annuity is not tax efficient nor attractive in terms of returns.  

Gold

Gold has traditionally been used as a savings avenue. But physical gold is not an investment because of challenges arising in purity, storage costs, wastage costs, and liquidity. Financial gold is more effective in capturing movement in gold prices without having to deal with physical gold. These include Gold ETF and gold mutual funds. Gold sovereign bonds issued by the government are also another way of investing in gold, and comes additionally with a small interest component and taxation benefits.

The positives: Its low correlation with stock prices and its counter to inflation makes it a good hedge against market risk.

The negatives: Gold as an investment does little to your overall portfolio. Their prices move solely based on global equity market sentiments and the exchange rate. Gold prices can and have stayed stagnant for long periods of times.

Stocks

By investing in shares (equity) of a company, you become a shareholder. The returns you reap will come from the growth of the company which will reflect in the price of the stock. There is no cap to these returns and stock prices can rise multi-fold. A small amount, therefore, can grow in very large sums. You need a trading and demat account to transact in stocks.

The positives: Equity has historically been the highest returning asset class. Higher returns mean you can invest lower amounts – so a large corpus target can be achievable even if your savings capacity is lower.   

The negatives: Picking stocks comes with high risk. It requires market expertise. Stocks can be very volatile and therefore require both risk appetite to stomach rapid change in values as well as conviction to hold on to the stock. While volatility evens out over the long term, it still needs time. It can be safely said that equity investing is not for all and you should refrain from investing directly in stocks if you don’t understand the equity market well.

Mutual funds

A mutual fund is a pooled investment vehicle which invests in equity, debt, or gold and is managed by investment professionals. Choice of investments and their management is made by fund managers. Mutual funds charge a fee for such management. Eventual returns will be decided by which asset class you invested in. Broadly, returns from equity mutual funds will be market linked whereas debt oriented mutual funds will be a notch or two higher than that of fixed deposits.

The positives: Mutual funds give you professional management of both equity and debt markets without you having to make choices yourself. The variety of mutual funds means that you can find a fund that matches all your requirements. Open-ended funds can be exited anytime, giving you flexibility to structure your investments around your needs. Debt mutual funds have lower taxes than bank or corporate FDs.     

The negatives: The same flexibility can turn harmful if not used prudently. Easy-exit and no lock-in feature of mutual funds can hamper long term wealth building if not used for the right purpose. You will also need to track your mutual funds from time to time to ensure that they continue to be good performers. 

What you should consider

Now that you understood features of different products, you need to see which ones suit you. For that, you need to consider two important things – your needs and your risk appetite.

First, let’s understand what risk here means. It is the uncertainty in returns and probability of losses. For example, returns from any equity product is volatile and cannot be predicted beforehand. Whereas debt-oriented products, like PPF and fixed deposits, are more predictable and low risk. The more you’re able to withstand volatility in returns and losses, the more risk you can take and vice versa. But why should you take higher risk? The trade-off here is higher returns. So, while equity (stocks and equity mutual funds) is risky, returns over time compensate for this. While debt (FDs, PPF, debt mutual funds) is low-risk, so are its returns.

Second, your needs. You can think of your needs as the purpose for which you need money. Split this into what you would need in the short term versus money that you can put away for your future. To keep it simple, call anything longer than 7 years as long term. If you don’t have a well-defined goal and you just want to save up your surplus, consider it to be long-term as you have no definite use for it.

How to make the choice

Two simple rules. One – longer the timeframe, higher the risk you can take and vice versa. Two – the more risk you can take, the more equity investments you can make and vice versa.

Here are a few pointers. For short term needs and contingency (emergency) funds, you’d need a stable source of returns, easy conversion into money, and low risk. You can consider bank FDs or debt mutual funds for that purpose. PPF is unsuitable because of its long lock-in. Don’t use equity-oriented products for short-term goals, no matter how attractive the 1-year or 3-year returns may look.

For long term wealth building or a timeframe of 5 years and longer, include equity as it delivers superior return and you can build more wealth. Be it through NPS or mutual funds or direct stocks, up your equity exposure longer the time frame and the more comfortable with the market. You can include an exposure of 60%-80% in equity for a period more than 5 years, depending on your risk level. Put the remaining in debt-oriented products like FDs or debt funds. Don’t put all your investments into equity – that’s just exposing your entire portfolio to high risk with no means to limit volatility.

Insurance products for the purpose of investment can be written off the list. Simply hold adequate term insurance (thumb rule is your sum assured should be 10 times your annual income) and medical insurance.

If you get confused by the array of products out there and whether you should invest in those, just do this – look at how it gets its returns, the risk level it involves, how long you can give that investment the time to perform, and how easily to can liquidate it either to meet your needs or if it is not performing well. Then blend these products to create a portfolio that suits different aspects of your needs.

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Six Financial Mistakes

How many of us know that the social security net in India is almost non-existent? And that your EPF is a very poor attempt at creating social security. NPS, a slightly improvised version, is yet to gain acceptance, thanks to its complexity and poor taxation structure. In such a scenario, it becomes imperative that we save enough for our retirement.

However, young people who join the workforce, are not geared towards financial prudence and do not start thinking about savings and investment right away. So here is a list of six mistakes one should avoid making early on in their financial life.

1. Delaying the habit of investing

Having spent our college lives on shoestring budgets, when we get that first salary credited to our bank account, we have a tendency to splurge. But hold on for a minute, this urge to spend now can get you into trouble later on.

The chapter on compound interest you had in school was not just theory. It is now time to see that into action. When you make any investment, your returns get compounded every year. The earlier you start investing, the more time your investments have to compound. The more your returns compound, the more you will accumulate.

Take the case of Ajit and Manisha. Both of them started working at the age of 25. While Ajith started investing right away, Manisha waited till she turned 30. Both of them invested similar amounts, Ajit starting with Rs. 10,000 and Manisha with Rs. 15,000. They increased it by Rs. 1000 every year. However, when they turned 60, this is where they both ended up:

Difference in investment value

A delay of five years caused Manisha to fall short by over Rs. 2 crore. So start early to accumulate a sufficient amount.

2. Spending through credit card

As soon as you open a salary account, you will get a call from your bank to get a credit card. Credit card is just the thing a spendthrift needs. You spend without worrying and pile up your credit. You barely manage to pay the minimum amount every month. And very soon, you find yourself paying huge amounts of interest on the accumulated credit.

Credit cards come with very high interest rates, going as high as 42% per year. Spending money you do not have can get you into a debt trap. You will eventually find yourself spending more money paying the accumulated interest, than you spent for yourself.

3. Spending using personal loans

OK, so credit cards are expensive, but what about personal loans and EMI payments? You will be bombarded with ads offering you pre-approved personal loans at rates as low as 14%. They tempt you into buying goods you cannot afford. You may have only Rs. 30,000 in your bank account, but you take a personal loan for Rs. 40,000 to buy the latest Google Pixel phone. You will take another personal loan and go on a Europe trip with your friends.

Spending on luxuries you cannot afford will only eat into your corpus. Instead, plan for the long haul. Start with cheaper gadgets and trips closer home. This will help you save more in the initial stages of your life. As you move up in your career, you will have more opportunities to splurge.

4. Investing without understanding the product

Another mistake which people make is to not spend time understanding where they should invest their money. A young person tends to receive advice from his parents, uncles, senior colleagues, and these days, knowledge sharing social networks. None of these will understand your needs or advice you properly. Investing without understanding the product can land you into trouble, the kind which people got into last year when they invested huge amounts in Bitcoins.

You should neither rush to put your money in banks, nor rush to invest in equities. Nor should you fall into the trap of Ponzi schemes. So take a couple of weekends to think about your investments. Spend some time understanding the products available and the pros and cons of each. Then make an informed decision.

5. Trying to stay away from risks

While there are people who put their money only in banks, there will be people who swear by equities. Neither of the extremes are good. While you should not take too much risk, you should also not be too risk averse.

Equity and equity related products like mutual funds are risky. But they also come with risk premium. There is a reward for taking ther risk and this reward is higher returns. Over a long period of time, even 1-2% return differential can create a huge difference in your corpus.

Here is a comparison of how much a monthly deposit of Rs. 10,000 grows to in 35 years, at various rates of interest:

Value of investment at varying interest rates

If you stay away from risk, you risk missing out on the huge potential of equities.

6. Buying a home too early

We have a great emotional attachment to our homes. Owning a house is also associated with social status and prestige. As a result, as soon as we start earning, we want to have our own apartments. Within a few years, we find ourselves saddled with a huge home loan, zero savings, and only one illiquid asset that is the apartment. The next few years are spent paying the EMI only. By the time we can start saving, we have already missed the early bus.

Don’t be in a hurry to buy a house. Again, after having saved for a few years and after having made some progress in your career, you will be in a much better position to buy a house according to your needs. Taking a home loan early on not only gets you into a financial mess, it also restricts your career choices.

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The EMI that Comes Back

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The only cure for the EMI lifestyle is an EMI where the ‘I’ stands for investment, and not instalment.

A huge proportion of salary-earners see their salaries getting credited and immediately decimated by EMI withdrawals automatically made by the lenders. The beginning of the festive shopping season leading up to Diwali is a good time to think of this problem simply because this is the time of the year when the lure of buying things is at its peak. Offline and online, the ‘festive offers’ have already started appearing.

It’s now incredibly easy to make an EMI borrowing casually and impulsively. Once upon a time, there was a lot of paperwork to be done before you could buy something on instalments. Getting 36 or 48 cheque leaves from a bank alone used to be a struggle, not to mention filling them and signing them without any errors. Now, it literally takes minutes and that too with hardly anything more than standard ID proofs. In fact, even minutes is too long. For example, buyers can instantly convert credit card purchases to EMIs. Not just that, a large financial services company has an ‘EMI card’ which encapsulates a pre-approved EMI limit. Consumers can just swipe a purchase and have it added to an EMI. One can imagine the effect of having an EMI purchase process that’s exactly the same as a card purchase, specially when this is available for online purchases.

The problem with all this obviously is that people overborrow and end up paying a huge amount of interest. Effective interest rates on consumer goods EMI loans tend to be very high, around 17-20% currently. Moreover, hiding this interest rate appears to be a standard part of salesperson training. If you ask about financing at a white goods store, you will be told the actual rupee amounts. The salesperson will say something like, ‘Rs 11,346 down and then Rs 3,876 per month for six months.’ Calculating the actual interest percentage from this data is beyond the arithmetic capabilities of almost everyone, even if you have access to a computer right there. All that a customer thinks about is whether the sums sound payable. If they do, even at a stretch, the deal is done and a huge interest burden is committed to.

There’s no point complaining about the interest rates, as many people do, specially on social media. Small loans are an expensive and risky business for lenders, specially on consumer goods which have trivial recovery value. It’s a competitive market and if lower rates were possible, someone would be offering them. Many lenders offer supposedly zero rates but in those cases, someone in the chain is paying the money and it all eventually goes in to your purchase price. Really, there is no escape from the EMI culture.

Except, by creating a ‘Reverse EMI’ fund yourself. Just try it once and you will be convinced. Choose a fund suitable for short-term investing. Start an SIP in such a fund, one that you would comfortably pay in an EMI. Whenever you feel like buying something, see if there’s enough money in your ‘Reverse EMI’ fund. If there is, just withdraw it and buy what you want. Otherwise, wait. There’s no need to treat this as savings. This is an expenditure fund. From an interest expense of 17-20%, you will end up having a return of 6-8%. That’s a difference of 25%! That itself could pay for some things that you may otherwise may not be able to afford.

Specially, for young people, doing this on a small scale (maybe just to buy that high-end phone) can be a lesson in how time affects money. In fact, if you have a young one who is pestering you for some gadget, make a deal with the child and create a Reverse EMI fund. And then, use the differential between the EMI cost and your fund’s value to buy a better gadget.

It’s a great demo of the fact that postponing expenses creates money while preponing them destroys it. This is the central idea of all saving and investing, and one that can act as the basis of a lifetime of financial comfort.

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