Mistakes investors should avoid while investing in the stock market

• Follow

Investments in stock markets come with its fair share of risks and rewards. Although there’s no guaranteed formula to ensure handsome returns, it is important investors do not make mistakes which may lead to heavy losses.

What are those mistakes?

Here’s a look at them:

1. Not Understanding Your Investment It is important to understand what you are investing into. Warren Buffet, one of the world’s most successful investors, is well known for cautioning against investing in companies whose business models you don’t understand. He recommends sticking to your core competence. If don’t have the time and competence to understand a stock investment, then the best way to build an equity portfolio is to build a diversified portfolio of exchange-traded funds (ETFs) or mutual funds.

2. Letting Your Emotions Rule Perhaps the biggest issue facing investors is letting their emotions like greed and fear to control their investment decisions.  Investors should therefore avoid buying at market peaks when levels of greed are high and selling at lows when fear is high.

3. Lack of Patience Many newbies in the stock market expect to make quick money and huge returns in a short period of time. This often results in losses due to lack of expertise and high risks taken, beyond what you can afford to take. It is better to adopt a slow and steady approach to portfolio growth and for this, you need to keep your expectations realistic with regard to the returns and time frames to achieve your investment goals.

4. Too Much Turnover Many investors tend to keep jumping in and out of positions, in the hope to catch every emerging opportunity. This can lead to higher transaction costs that can eat into your profits. You also have to pay the short-term tax rates (which are usually higher) and there is the opportunity cost of missing out on the long-term gains of the investments you sold early.

5. Holding On To Losers And Booking Profits Early This is a common mistake made by many investors as they tend to hold on to their losers in the hope that they recover to their cost price.  By failing to book a loss, investors are actually losing in two ways. First, the losing investment may continue to slide lower. Second, there’s the opportunity cost of the better use of those funds invested.

Also, profits are booked early rather than allowing them to grow and contribute to the profits of the portfolio. This will prevent building wealth over the medium/long term.

6. Failing to Diversify or Overdiversifying Many investors tend to invest in a few stocks in the hope of generating above-average returns. While professional investors may be able to achieve healthy returns with their in-depth knowledge of the companies, common investors would be better off investing in a diversified portfolio of stocks. which includes all major sectors. A rule of thumb to adopt is to not allocate more than 5% to 10% of capital to any one investment.

On the other hand, some investors have an unwieldy portfolio consisting of scores or hundreds of scrips. This is counterproductive as excessive diversification could result in subnormal returns.

7. Falling in Love with a Company Too often, when we invest in a stock whose share price has appreciated substantially, we tend to fall in love with it and do not want to sell it. This may not the right approach because no stock can rise forever and will one day eventually come down either due to a change in fundamentals or due to overall market weakness. It is therefore important to develop exit strategies to lock in profits before there is a major reversal in price.

(The writer is Head of retail research at HDFC Securities. Views expressed are personal)