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The big mistakes that direct equity investors commit, and how to avoid them

Overestimating the potential of equity markets, just on recent returns, and under-estimating the effects of inflation can come in the way of wealth creation.

May 18, 2022 / 10:22 AM IST

We conducted an employee investor awareness programme for a corporate recently.  It was very well received, with attendance much in excess of what was expected.  As part of this programme, many of the attendees opted for a one-on-one consult on their personal finances. This exercise made us sit up and take a closer look at something we’ve been seeing on and off over the years — the fact that many people make simple yet fundamental mistakes that can seriously hamper their wealth creation journey.  We list out five of those mistakes below.

1 Underestimating inflation

Almost everyone we interact with is keen on being financially free in 10 years or less but they are unable to estimate the effect of inflation on their expenses. A good rule of thumb to remember would be that at 7 percent inflation, your expenses will nearly double every 10 years, even when you are conscious of not unnecessarily upgrading your lifestyle.

So, if you’re spending X amount today, you will be spending 2X in 10 years, 4X in 20 years, 8X in 30 years and so on. Simply put, because people underestimate the effect of inflation, the actual corpus required for financial freedom is often much in excess of what people estimate it to be.

Another fallout of the effects of inflation is buying products such as money-back and endowment insurance, which pay back a fixed amount at the end of 10 or 15 or 20 years. What needs to be kept in mind is that the actual value of the money you receive will be half in 10 years and one-fourth in 20 years. Hence, while the payout seems substantial today and the purchase seems to make sense, when you add the inflation angle, the security and peace of mind you get on buying these products is short-lived.

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2 Committing very little

In the workshop I mentioned earlier, most of the participants were DIY investors. They were deciding on what percentage of their savings need to be invested and where to invest them without any professional help

Thanks to the internet and the overload of information available, most of them were aware not only of basic products such as mutual funds, they also had a fair idea about exotic products available in the market today. What they lacked though is conviction. Two of the attendees had a huge corpus that they had saved in recurring deposits (RDs) and fixed deposits (FDs). They were aware that these investments were not right for their situation. So, they invested a very small portion of their savings in equity mutual funds and stocks (put together it was less than 20 percent of their corpus).  Doing this, they were happy to have taken some action and were content.  One must realise that time is of the essence when it comes to investments. At this rate of transfer into growth assets, they would take a good five years to just ensure that they had enough exposure to meet their goals.

3 Focusing on the short-term

Undue attention is being given to short-term performance. The goal for many of them was to be invested in the top performers. Unfortunately, even the best of funds or stocks will go through phases where they slip from the first quartile. This can happen due to various reasons and is not reason enough to dump the investment and look at greener pastures.

Once you choose your product with care and proper due diligence it pays to hold on to the investments for some time and reap good benefits. Being in shopping mode constantly confuses you and will lead to bad decisions.

4 Giving your choices more credit than is due

Equity markets have had a good run for the past two years. A few of the attendees were very upbeat that their choice of products had yielded superlative returns. It is important to take a moment to see that the overall market has given good returns and hence even sub-par selection of funds/stocks is likely to have outdone traditional products such as FDs and RDs by a good margin. The trend will turn when there is a downturn in the market, which is bound to happen sooner or later. It is very difficult to have the conviction to hold on in volatile markets without having clarity on the reason for the downturn and the faith that your investment will remain good even through the correction.

5 Investing without a plan

Without a plan, decisions can be ad-hoc and determined by the recent performance or expectations of a good outperformance. These choices may not be suitable for your situation or goal. Here, I am reminded of a quote by author Erin Morgenstern, and while the original quote was in a different context, it fits this one too: “I saw in details while she saw in scope, not seeing the scope is why I am here and she is not. I took each element separately and never looked to see that they never fit properly.”

And so, if you have the good fortune to meet someone who can help you customise your investments keeping your interests in mind, it would be worthwhile to explore the option and see what benefits it brings to the table.

Dear DIY Investor, it may be worthwhile to remember that investing is not a purpose in itself, as much as a method to achieve a certain purpose. And key to ensuring that you have a successful investing journey is understanding why you are investing and what guardrails need to be put in place so that you don’t “fall off” during the journey.
Prathiba Girish is a Certified Financial Planner and Founder of Finwise Personal Finance Solutions
first published: May 18, 2022 10:22 am
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