A Chartered Accountant and Company Secretary, Sanjay is a first-generation entrepreneur with an experience of more than 25 years in Investment Banking. He’s also an avid investor in early-to-growth stage companies and a philanthropist.
I have previously written about the mistakes a basic investor can make, and the traps they fall into. Seasoned investors would have probably read it and had a good laugh at it. But let me turn the tables on them. They make mistakes too, and pretty big ones at that, sometimes making them while trying to avoid the basic ones. Let’s look at a few here, but let’s recap the basics first (it always pays to revise your fundamentals).
- Don’t invest in the stock market if you are fishing for short-term gains.
- Investing has nothing to do with sentiment.
- Past performance of a stock is no indicator of the future.
- Never skip the fundamentals of the stock – it won’t do well if the company is not doing well.
- Cut your losses in time.
- Higher risk can lead to higher reward, but only if you hedge your investments.
Pothole #1: The Encashing Mistake
There’s no point of investing in stocks if you are never going to encash them for the joys and needs of life. A world tour or a comfy house or urgent medical expenses. Now, what is a wise way to encash, and what is dumb?
Let’s say you have two stocks in your portfolio that you think you can liquidate. Your stocks of Get Rich Fast Co. have lost value, while stocks of Slow, Steady & Sons have risen. Psychology tells you to sell off the latter, because you made a profit and your emotional brain will feel nice. But if you do so, you will end up with more of the dud stock in your portfolio, and your chances of getting rich quickly will recede. Whereas your rational brain (which one usually ignores) will be screaming that you should have sold the Get Rich Fast Co stocks. It would have given you the cash you wanted while your portfolio actually becomes better; and if your portfolio was diverse enough, the loss would only have been in your head.
Pothole #2: Going by Past Experience
Isn’t that the same as the basic error of going by past performance? Yes, but seasoned investors still fall into it. Say you bought stocks of Paisa Hi Paisa Co in the past and burned your fingers. The stock is rising now – but your doodh ka jala heart doesn’t want a sip of this chaas.
Perhaps the company has been taken over by new management and turned around. Or perhaps the company is still run by the same, ineffective management. In either case, will you go by past experience, or by the filings with SEBI?
Those of you who invested in Satyam Computers will remember. The share price collapse in Jan 2009 after the accounting scandal was revealed, burning several investors. The company was taken over by Tech Mahindra in late 2009 and returned to profitability in 2011, announcing a 30% dividend.
Pothole #3: Losing Sight of Your Goals
This is taught at the very start, right? You got into investing because you had some goal in life – a new house, a new yacht, to go to space (nowadays a trendy aspiration for CEOs). Somewhere along the journey the goal was met, but you discovered that investing is like chips – no one can eat just one. And now you’re heavily into it, selling and buying without any overall purpose except to make money. There is a word for such people – dedh-shana.
If you have met a goal, now is the time to re-evaluate your portfolio. Have you built enough assets to consider a higher risk appetite? Or are you getting a bit old (and we are not so mentally agile as we age) and should be thinking of paring down your risks?
Pothole #4: Confusing Value for Price
You may have heard the term value investor (if not, Google right now). These are wise people, who invest time in studying balance sheets, to determine the actual worth of a company’s shares. They don’t take the current price on the market at face value. It is a thin red line that differentiates the two, but it makes a whale of a difference.
If you find yourself in such shoes, you might realize that your portfolio may have some undervalued stocks (cheaper than they’re worth) and some overvalued ones (costlier than they should be). You might want to find the reason why, though, before you decide to buy or sell.
Pothole #5: Watching Too Much CNBC-TV18
You may laugh at investors who don’t watch business channels or read business news online. Well, I have nothing against them; I think they are good and reliable source of news and analysis. But I will laugh at you if that is all that you watch and read.
Smart investors read the news. Wise ones analyze annual reports and balance sheets of the companies they choose to invest in. The really wise ones read SEBI reports and other intelligence (CRISIL, Moody’s KPMG etc). But if you are truly invested, you will buy a ticket to attend AGMs and question the management.
Pothole #6: Not Diversifying Enough
Seriously, have you hedged enough? The 2008-9 Global Financial Crisis was entirely because of individual and institutional investors being over-leveraged and under-hedged.
Yes, yes, I know you have stocks in various companies. Perhaps across 4 or 5 industries. You will have a house or two and perhaps land. And I haven’t met an Indian investor who will not have some gold and silver in their house. But is that enough? I have known several investors on life who thought they had hedged enough, just to find themselves sending their pushtaini zameen at heart-breaking prices.
How about mutual funds and other ETFs? You know these are nice, passive investments that still yield nicely over the long term. Corporate bonds and debentures? Bank deposits? Salespersons for mutual funds and stockbrokers will try to wean you away from the middle-class practice of locking up money in banks, but I find it always helps to stash some money away in them. Nothing beats them for liquidity.
And finally, how much do you have in government instruments, which come with a sovereign guarantee? The famous investor and author Nassim ‘Black Swan’ Taleb had an investment strategy of 20% in US Treasuries and betting the remaining against inflated stocks when the 2008-9 bust happened – skyrocketing him into the millionaire club. But had the bust not happened, he would have “slowly bled to death” in his own words.
Pothole #7: Following Your Heart
Your heart is naturally greedy. It wants more and more out of life. As you become a seasoned investor and learn to avoid common pitfalls, your confidence can go to your head, and your innate greed can overpower your sense of caution. It has happened to me enough – and yet it the most basic of lessons the most seasoned of us forget first. Impatient greed is pure evil. However, ambition tempered with caution, can get you somewhere. Sadly, we only learn this by experience.
Pothole #8: Following Other People’s Hearts
Everyone around you is buying when stocks are rising and making a killing. You want some of the action too – because, well, who doesn’t want to have something to boast about at the end of the day? And so, you also contribute to a bubble – while your investor sense is crying hoarse that the bubble will eventually burst.
You might want to keep your internal radar in better shape. If the Sensex or Nifty are rising like crazy, what is buoying them? Are they the stocks of tech companies (I think the preferred word is unicorns nowadays) that are overvalued and overleveraged?
Are people betting their own money or borrowed money? Is the market being led by complex derivatives? Remember, Warren Buffet called them Weapons of Mass Financial Destruction. If these things tempt you, then switch off your computer, and repeat slowly to yourself, “Dotcom Bubble… Lehman Brothers… Dotcom Bubble… Lehman Brothers…” until the mania passes.
At the end of the monsoons, the municipality will hurriedly fill potholes. Just the right time for us to see which ones we fell into.