5 Common Mistakes First-Time Investors Make and How to Avoid Them

Becoming an investor is probably one of the best decisions that you can make – and perhaps the easiest way for you to fail in your first years of investing. The reasons for making a beginner mistake usually have nothing to do with choosing the “wrong” stock. Here are five of the most frequent ones and ways to avoid them.

1. Trying to Time the Market

New investors usually tend to wait for the “perfect time” to begin investing – after a pullback, after an election, or after things seem to have “calmed down”. However, it should be noted that market timing involves getting right twice – both times to sell and buy. Professional fund managers, along with all of their analysts, fail to accomplish this regularly. It is even less likely to be successful if you look at your phone screen to see if stocks are cheap enough to buy.

Market timing may also create its own cycle of fear and hesitation. Investors keep delaying their investments, expecting stocks to go lower and then find out that prices went back up without their participation. On the other hand, people who bought shares after a significant rally may become worried about stocks falling again.

The fix: Apply rupee cost averaging or dollar-cost averaging, which means putting in a fixed amount periodically irrespective of the price. It eliminates all the emotional guesswork and helps even out your average cost over time. The most beneficial approach for anyone to adopt is the periodic SIP (Systematic Investment Plan) in a diversified fund.

It is not about predicting the market. It is about making an approach that works during periods of rising as well as falling markets. Periodic investments also make it easier to develop a habit of investing due to its systematic nature.

2. Chasing Last Year’s Winners

It seems very appealing to invest one’s money in a particular fund or industry, depending on how well it has performed the previous year, whether it is a technology fund, an industry like PSU stocks, or even cryptocurrencies recommended by a friend. However, performance chasing ends up being a bad idea because industries and investing strategies are cyclical, where what worked last year might not work the next year, and when the masses pile in, most of the gains would already be baked into the price.

Performance numbers might be helpful, but they don’t necessarily tell the full story of what lies ahead. A fund that did extremely well under a certain set of market conditions might have profited under conditions that are unlikely to persist anymore.

The fix: Evaluate the investments based on their performance over several market cycles (at least 5-10 years) and not just for one standout year. If the fund’s return seems too good in comparison with the category’s average, find out the reasons for this abnormality since usually a fund’s good performance is explained by its highly focused nature on one specific sector or theme – which can work against it when going down.

Think about whether this investment suits your personal objectives and risk profile. An investment must never be chosen only because all others around speak about it. Platforms such as Zomint.com can also be useful when researching investment opportunities, but investors should still evaluate an investment based on its objectives, risks, costs and suitability rather than following market trends.

3. Ignoring Fees and Costs

“1%” may seem insignificant until you take into account how the expense ratio will affect your total returns over the span of 20-30 years. As a beginner investor, you might miss out on the importance of the expense ratio since this is deducted from the fund’s NAV and not billed to the investors, thus making the cost invisible to the eyes even though it exists.

When you stay invested for many years, the importance of the costs cannot be overstated. This is especially true when comparing funds that offer exposure in similar ways.

The fix: Look at expense ratios first, and compare everything else secondly. Direct plans, for example, do not include distributor commissions and thus stand a chance of outperforming its regular counterpart in the long term because of this cost factor. In addition to the expense ratio, be mindful of the exit load, transaction cost, and advisor fee among others.

It should be noted that low-cost investment isn’t always the right kind of investment. Expenses must be put into consideration together with the investment’s strategy, portfolio, risks, past performance, among other factors. The main thing is to know what costs you pay and the benefits you gain.

4. Putting All Your Eggs in One Basket

It can be as simple as investing all money in one single “hot” stock, one particular sector or employer’s stock via stock options. It seems to be quite a safe strategy since you have enough knowledge about the company. Still, knowledge is not security.

However, even the best company can come across some problems. The change in regulations, industry dynamics, management problems or even economic recession may influence investments heavily. If most of the capital is invested in the stock of just one company or one particular sector, losses in this particular investment may leave nothing to defend.

The solution is to distribute investments among asset types (equity, bonds, maybe gold or real estate), market caps (large, medium and small) and sectors. Diversification can also extend beyond domestic markets through global investing, giving investors exposure to companies, industries and economies outside their home country. Global investing can help broaden a portfolio, although it also introduces considerations such as currency movements, foreign-market risks and taxation.

5. Investing Without an Emergency Fund or Clear Goal

Most novices invest directly into the stock market using money that they might need after six months, and subsequently panic and sell off their investment after realizing losses following a drop in the stock market when an emergency occurs. Another type of investment that does not come with any objective is as dangerous in its own quiet way, whereby one cannot decide what level of risk he or she should invest at.

It is because the time horizon becomes relevant here since investments can react differently based on the duration, and the equity markets can fall sharply within a fairly short period.

The fix: Create an emergency cash fund (usually around 3-6 months’ worth of expenses) before getting into stocks, so that the volatility in the market doesn’t make you do anything wrong. After that, allocate every investment towards an objective and time period. Long-term objectives can take on more risk from the equity market, while short-term ones should be invested in safer avenues like debt schemes and fixed deposits.

Having an objective will help track the success of your plan because now instead of only keeping a check on your portfolio, you know whether your saving and investing is taking you anywhere financially.

The Bigger Pattern

Take note, all of these errors are not caused by choosing the wrong asset; they are due to the fact that the investor’s actions have been driven by behavioral biases such as impatience, herding, ignoring costs, overconfidence, and lack of planning. The best thing is that all these five mistakes are totally preventable with just some form of structure.

Investing doesn’t have to be a matter of continuously watching the market and making complex decisions. For the novice investor, simply having a process can be far more helpful than predicting what will happen next. A process involving automatic investments, diversification, costs, and investment goals is a better basis for making investment choices.