4 expensive misadventures in investing

Markets have seen steep falls since the Covid 19 lockdown.

I shared my thoughts with Larissa Fernand on errors and misadventures that can destroy portfolios, based on queries I've been receiving from investors since March. These were published in The Morningstar 

4 expensive misadventures in investing 

Based on interactions with clients, friends and acquaintances, MAHESH MIRPURI recently tweeted about what is going on in the minds of investors. 

Being a financial coach and adviser, he neatly put it across as misadventures in investing. Here he fleshes out the points to caution investors on how to be wise in such uncertain times. 

Here is something that you must know: You can gain substantially in your portfolio by avoiding mistakes. Win, by not losing. Skip these misadventures, and you are automatically ahead in the game. In fact, it is more crucial to avoid certain errors, than hunt for the “best” instrument.

The misadventure: Ignoring risk when chasing a higher yield. 

The Reserve Bank of India recently lowered its repo rate to 4%, and the reverse repo rate to 3.35%. 

The repo rate is the rate at which the RBI lends to other banks. The reverse repo rate is the rate at which the RBI borrows from banks.These are the benchmark rates in the economy, which means that these as such, form a basis for all other interest rates. 

Worth noting is that these are the lowest rates we have had since 2000. With India facing an economic downturn, the rates may not rise soon. Banks have consequently dropped lending and fixed deposit rates and this has made senior citizens anxious. 

To compensate, investors are now looking at instruments that offer a higher return, choosing to ignore the risk of losing capital. Senior citizens have enquired about Company FDs, NCDs and other instruments which carry a risk of losing capital. 

Please consider safety of capital more especially, at this critical time like this. Senior citizens can consider the Senior Citizens Savings Scheme @7.4% or RBI Taxable Bonds @ 7.75% or the Pradhan Mantri Vaya Vandana Yojana – a pension scheme.  A host of other small savings schemes are also available.

 The misadventure: Playing the guessing game. 

I keep getting calls or requests for advice on whether a stock is a good buy at a particular price. "Stock ABC was Rs 500. Today, it is quoting at Rs 350. Should I buy?” 

I answer such queries by posing another question: What is your anchor? 

Let me explain. We don’t realize how dominant the anchoring bias is. This is when our brain unconsciously seeks a reference or starting point when guessing an answer. 

Let’s say I began to track a stock when it was Rs 3,000. Now that it has dropped to Rs 2,000, I believe it is cheap. But is it? To really figure out if it is cheap, you must study the stock in detail. Maybe it is still expensive at Rs 2,000. Maybe it was cheap at Rs 3,000 and is cheaper still. And if that is the case, why is it falling so rapidly? Is there a reason it is plunging faster than other players in the same sector? 

Don’t rush to buy because your mind is anchored to a previous price. Study. Analyse. Don’t guess.

 The misadventure: Betting recklessly. 

After Demonetisation, it was a dream run for the Indian stock market.  

The Sensex stood at 27,591 on November 8, 2016. As millions of investors channelized their money into equity funds since interest rates dropped substantially, there was a phenomenal rally – and spectacular gains in small and mid caps. Seeing recent performance, thousands of investors poured money into small and mid cap funds and stocks, fuelling a stellar run. And while there were substantial corrections along the way, the Sensex touched an all-time high of 41,000 before this steep fall. 

The problem is that many investors flocked to the asset class with no clue as to how volatile it can be and how punishing a steep fall can be. 

To add fuel to the fire, many investors have invested a substantial part of their financial assets into equity alone. Zero respect was paid to asset allocation. Such portfolios have suffered tremendous damage.  

Never bet recklessly on one single asset. Always ensure proper asset allocation and diversification.

 The misadventure: Chasing returns.

 This has always been an investor weakness. Invest in the sector once it rallies. Invest in a fund once it tops the chart.  

A number of investors now want to bet on gilt funds. Why? Because they have put up some excellent return figures. No one considered them when yields were high. Today, when 10-year paper is at 5.96%, maximum enquiries come in for gilt funds. Why? Because investors are looking at the recent past performance, without enquiring into why!  

Agreed, gilt funds have no credit risk. There is no risk of default. But they do have interest rate risk. 

In simple language, if interest rates rise, the price of the bonds will fall. If interest rates fall, the price of the bonds will rise. Interest rates (yields on bonds) have fallen tremendously and this means bond funds have given very good gains. Now instead of chasing such funds, ponder, how far lower can interest rates go? 

If you wish to invest in gilt funds, understand the offering and consider it as a tactical play. I have written about it in How to build a debt portfolio. 

Investing simply based on recent performance can turn out to be a misadventure. 

In conclusion, to avoid the mistakes enumerated above, develop a deliberate and thoughtful investment process and stick by it. You will be well on your way to having a good investment portfolio.