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Thursday, September 23, 2021

Are you unknowingly committing these costly investment mistakes?

Here are a few rather common investment mistakes you might be committing without realising, and ways to overcome them to avoid resultant losses.

Written by Adhil Shetty |
Updated: August 13, 2021 7:23:29 pm
When investing, people often make the mistake of not diversifying their portfolios in sync with their financial goals. (Representative image: Pixabay)

Investments play an extremely important role in helping us to achieve our short- and long-term financial goals. However, a few costly investment mistakes can deeply hurt your personal finances; thus, you need to be aware of them in order to avoid them. Here are a few rather common investment mistakes you might be committing without realising, and ways to overcome them to avoid resultant losses.

Investing without financial goals

Investing without a financial goal is like eating food without an idea about your appetite or your health condition. People who invest without any financial goals attached to them may face many situations where they fall short of funds in the face of an important requirement. Doing so can also result in unnecessary debt, financial hardships and a financially deficient retirement. In the last scenario, investors are unlikely to have adequate income to fix their mistakes.

As such, when you start your career, you must identify your short- and long-term financial goals and accordingly make an investment plan to achieve each of those goals in line with your risk appetite and liquidity requirements. Such goals could be, for example, a fund worth Rs 5 lakh to buy a car after two years, a fund worth Rs 20 lakh to buy a house after five years or to raise a Rs 5 crore retirement corpus after 35 years.

Not checking expenses related to investments

Investments like shares, mutual funds, etc., have some associated expenses. For example, when you invest in shares, you may need to pay brokerage charges, exchange fees, etc. When investing in mutual funds, you may be required to pay an expense ratio depending on the type of fund and the mutual fund company. Such expenses may snowball in the long-term depleting your investment returns to that extent. As such, when investing money in an instrument, you should focus on the returns after deducting the applicable expenses to get a clearer picture.

Ignoring the real rate of return

Many investors focus only on the nominal returns of their investments and, thus, make a big mistake. A nominal return is a return generated by an investment without adjusting the expenses, taxes, inflation, etc.

For example, suppose you have invested Rs 1 lakh in an FD for one year at an interest of 6 per cent p.a. In this case, you’ll earn a nominal return of approximately Rs 6,136. Now, if you fall in the highest tax bracket, your FD returns will be taxable according to your tax slab rate. So, your returns would only be Rs 4,295 post taxes. Then comes inflation that consistently depreciates the value of money. Assuming the rate of inflation during the investment period as 3 per cent, your real rate of returns (i.e. inflation and tax-adjusted) would only be Rs 1,295, i.e. only 1.29 per cent despite nominal returns being 6 per cent.

It’s a very common mistake to focus only on the nominal returns that, at times, may lead to even negative returns. So, before investing, make sure your investment gives you as high a positive real rate of returns as possible. Earning a high real rate of return can help you in wealth creation in the long term.

Not considering the tax liability

Not knowing the tax liability associated with investment products can also lower your returns. Tax obligations on short-term and long-term income from investments in assets like equity, debt, real estate, etc., vary significantly. So, before investing, know about the tax applicable on the income from such investments. It can help you choose tax-efficient investments and offer you higher returns in sync with your risk profile and investment goals.

Not ensuring sufficient liquidity

Investment is necessary to fulfill your financial goals, but investors often forget to take care of their liquidity needs during this process. Investing without taking care of your liquidity needs may result in a financial crisis in managing day-to-day expenses or emergencies. You’ll be well-advised to set a liquidity threshold factoring in your rent/home loan EMIs, utilities, insurance, etc. and invest the surplus funds intelligently in line with your goals and risk appetite. You should also think it through when investing in instruments that require long lock-in requirements evaluating the impact of the unavailability of the invested funds until maturity of such investments.

Not diversifying adequately

When investing, people often make the mistake of not diversifying their portfolios in sync with their financial goals. ‘Adequate’ diversification means neither greater nor lesser than what’s essential to lower the overall risk in your investment portfolio. Over diversification often leads to lowering your return on investment; on the other hand, under diversification may expose your portfolio to volatility risk, and it may not fulfill your purpose. So, when diversifying your portfolio, don’t overdo and maintain several asset classes in your portfolio and multiple schemes within an asset class with varying degrees of risk and returns. Also, maintain a portfolio size which you can easily manage.

Investing based on hearsay

Should you blindly follow hearsay on investments? The answer is no. In fact, investing purely based on hearsay advice such as stock tips, mutual fund scheme ideas, etc., can attract heavy losses. Thus, always put in the required effort before investing to know the rules of the game by reading investment-related books or articles, watching tutorial videos or even signing up for an online course. If you have any doubts about investments, you should ideally consult a certified and neutral investment advisor instead of taking hearsay-triggered investment decisions.

The author is the CEO at BankBazaar.com. Views expressed are that of the author.

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