Making money is mostly about avoiding losses and not making the same mistakes repeatedly. Here are some common errors to avoid.
1) Focusing too much on past returns
Investors often stick to a limited amount of information about the funds they invest in. They may see a fund's category, as well as its returns over a certain time period, such as the past five years. So it is no wonder that many investors simply reach for the funds with the highest numbers. That's certainly not a recipe for great investment results, as those high performers often revert to the mean. Rather than chasing the hottest performers, investors are better off focusing on fundamental information about funds' strategies, management, and expenses to help populate their asset-allocation mixes.
2) Focusing too much on lost opportunities
This aspect is closely related to the first. Investors often want to purchase funds and asset classes that have strong performance in recent periods and sell funds and asset classes that have lagged. Such behavior reflects emotion rather than rationality. So when infrastructure as a theme was doing well around eight years ago, investors flocked to such funds. The same is seen with other sector funds. Naturally, the rally will stall sooner or later. And then the disappointment investors flee for the exits. So what happens is that they buy high and sell low. A catastrophe when attempting to build wealth.
Scott Burns, Director - Global Fund Research, Morningstar did a study of an American fund to demonstrate the difference between total return and investor return which he presented at the Morningstar Investment Conference in 2013 in India. Total return is a time-weighted calculation that looks at a time period of holding with no additional investments made along the way. Investor return is a money-weighted calculation that takes into consideration aggregate monthly purchases and sales by all of the fund’s investors. The fund boasted a 10-year total return of 15.05% while the 10-year investor return was a pathetic -1.46%. Investors must understand that all noise is not a signal to act. Think before you invest and then have the patience to ride the storms.
3) Not focusing on real returns
Consumer prices in India have risen every year. That means you need more money to maintain your current standard of living. An assumed low inflation rate of 4% will reduce the value of Rs 1 lakh today to approximately Rs 67,500 in 10 years. And do note, this is a low inflation rate and we are not even taking taxes into account. A high rate of inflation would erode the value of your savings. If we look at the CPI over the past decade, inflation has varied from 3.78% to almost 15%. (Source: Inflation.eu – December vs December from 2004 to 2013). Now add the tax factor to this, and you may realise that your savings are not at all that much.
4) Focusing too much on fixed income
In continuation with the thought above, to beat inflation, investors must look at equity. It’s all very well to park your money in fixed-return instruments such as fixed deposits, National Savings Certificate and the likes. But once you take inflation and taxes into account, your real return drops. You have to make up the shortfall and equity helps in doing just that and building wealth. Don’t shy away from maintaining an equity exposure in your portfolio. If you choose to do so, you could be jeopardising your entire financial plan.
If you look at the category average of large-cap funds, according to Morningstar’s categorisation, the annualised return is 17% over 10 years. If you hold your units for over a year, then long-term capital gains is nil. If you invest in an equity linked savings plan, or ELSS, you also get a tax break under Section 80C.
5) Focusing too much on noise
Macroeconomic news, whether it's the direction of interest rates or GDP growth or news around the globe, often appears right alongside news about the market's trajectory. And it's true that what's in the headlines has the potential to move the markets up or down on a daily basis, or even over longer time frames. The trouble is that by the time a certain news item makes its way into the headlines, other market participants have already digested it and priced it in. If you decide to sell your fund based on that news, you're likely to be too late. Instead, a better tack for investors, at least as it relates to their portfolios, is to keep their heads down and focus on factors that they can control: their savings and spending rates, the quality of their investment holdings, and the total costs they pay for those investments.
