Mistakes to avoid in equity investment
Equity investment makes a compelling argument for being included in long-term growth portfolios. This is due to the higher inflation-adjusted returns equity investment generates. Here are a few practices that you should avoid since these practices increase the risk in your portfolio.
Timing entry, exit
Unless you are an expert at interpreting technical indicators, you will not be able to call the market’s highs and lows with too much success.
Most common investors would not have an in-depth understanding of all the events. Frequent entries and exits from any investment instrument lead to additional costs, which eat into your returns.
During the time that you wait for signals to indicate the right time to invest, your money will be lying idle.
Similarly, trying to time your exit according to a market peak has disadvantages too. First, you may not have the money when you need it. Second, the market may decline before you are able to monetize your investment.
It is important not to use borrowed funds to invest in volatile assets. Returns from such investments have to go towards servicing the loan. And while returns can be high in best-case scenarios, if such investment tanks the losses will be more with long-lasting impacts on your life.
Leveraging magnifies losses as much as it does the gains and is, therefore, a risky strategy to adopt for volatile instruments.
Growth assets with high long-term average returns need a long investment horizon.
Higher returns from such investments can be had by giving them time to ride out turbulent markets or economic downturns.
If an investment is made after adequate evaluation of the fundamental factors and it periodically monitored, then it should be held in the portfolio for as long as the goals require.
It is important to tune out the noise of short-term market responses to events and focus on the long-term prospects of the investment.
A high return on long-term investment does not guarantee the same level of returns over a shorter holding period.
Investing funds earmarked for immediate goals in volatile investments, to earn higher returns, may not always be successful. A fall in market values during that period will depreciate the capital invested.
Booking quick profits
Trying to exploit an upward momentum in an investment, to make a quick profit, is a risky strategy unless you have the tools and information required to time and execute such trades.
Inexperienced retail investors are likely to enter into a trade when the momentum has petered out and the prices are retracting.
Sometimes such investors are unwilling to cut their losses and exit. This may happen even as the prices continue to sink further. At other times, greed may make them ignore the signals to book profits and they stay invested in the hope of higher prices.
The availability and regular updates on prices, and ease of making transactions make it tempting to use such strategies to make a quick profit.
But given the hits and misses, as well as the costs and taxes, the cumulative outcome may not be all rosy.
Chasing past performers
Chasing last year’s best-performing asset class, industry, strategy, or product category can put your goals at risk. The risk is that the previous year’s best performers need not be the same this year.
Chasing performance necessitates moving funds from one investment to the next, which implies costs and taxes that affect net returns. It may result also in buying products that are not aligned with the needs of the investor.
The portfolio has to reflect your goals and the ability to take risks. A diversified portfolio that is aligned with the goals will take care of having exposure to multiple asset classes.
Monitor the investment performance and consider a rebalancing only if there is consistent underperformance relative to valid benchmarks and peer groups.
Investments that have the potential to generate higher returns come with greater fluctuations in their returns. Keep the focus away from the volatility and instead focus on your investment plan.
Having a plan that reflects your risk and returns preferences will help ride out the troughs and get you to your financial goals.