Recently, I received a request from one of my friends to review his portfolio. I was surprised to notice that most of his stocks were in losses, despite markets (Sensex) having risen about 30% in the last one year. A casual chat revealed that he had invested in those stocks over the last 2-3 years after listening to expert advice on popular financial news channels. Unfortunately, he did not do personal analysis before investing in those stocks and bought them based on media recommendations.
About 75% of the stocks were in losses with many losing up to 50% in value. While analyzing the stocks, I noticed that some of the companies had never made profits in their entire life. Some other companies had stagnant sales & profits for last many years. A few other companies were making cash losses and were relying on debt financing to fund their operations & investments.
I suggested him to sell most of these companies. However, my friend, like many investors, did not want to sell them at a loss. He thought of holding on to these stocks in the hope that improving economic situation and ‘the Modi effect’ might help him achieve his buying price. Thought of buying more shares of these companies to lower the average buying price were crossing his mind.
I realized that my friend, like many other gullible investors, was making some of the common mistakes that almost every stock market investor makes:
Most Common Mistakes Made by Investors
1. Misinterpreting Financial News Channels as a Reliable Source of Investment Information:
Despite understanding that financial channels are profit centres that are run to grab viewership (aka eyeballs), many investors can not stop themselves from investing based on their advice. The sole job of news channels is to get more & more eyeballs interested in their programs with continuous buy and sell recommendations day after day. News channels have to make the financial world thrilling for the viewer so that she gets addicted to it. Every other day, some stock must be presented as a strong buy and some other stock as strong sell to keep the viewer engaged. Financial channels never show the analysis of the performance of all buy & sell recommendations by their experts in the past.
2. Seeking Advice From the Wrong Advisor (TV Experts):
Everyone needs the advice to take decisions in areas where they do not have expertise. It happens in every aspect of our life whether personal or professional. We seek advisors to help us. However, not every time the search leads to the right advisor. We see people flocking to mushrooming religious saints (many of them now jailed) and similarly, many others relying on TV experts.
Past studies have shown that TV experts are not able to beat the markets. There have been also some cases where the expert has sold shares from his personal portfolio after giving buy recommendation for the stock on the channel. Many experts are known to be making more money from TV shows than from personal investments.
3. Letting Emotions Influence Investment Decisions:
Many investors, despite recognizing that the stocks they have invested in are not good companies, are not able to sell them. It becomes very difficult to take the sell decision. Psychologists have said that we as humans do not like to take losses. We would prefer to avoid losses than making gains. The main aim of the investors narrows down to recovering the buying price of their stocks. Investors are willing to put in additional money in non-profitable companies if it could help them recover their losses faster.
4. Not Comprehending the Opportunity Cost of the Money:
Many investors are willing to give more time to non-performing companies until the time they came out of losses. Some investors invest more money in them. It amounts to throwing good money after bad money. An investor should understand that money kept in a bad investment for one year has a lost opportunity of the money invested anywhere else.
We notice that my friend has been a victim of some of the common mistakes, which most of us make while investing. However, we should understand what my friend and many other investors in a similar situation can do to avoid similar mistakes and build a good portfolio of stocks for long-term wealth generation:
Simple Steps to Avoid the Most Common Investing Mistakes
1. Conducting Own Analysis before Buying any Stock:
An investor should avoid acting on the information presented by news channels. She should conduct her own analysis of the recommended stocks before making the decision to invest her hard-earned money. Selecting good stocks for investment is a simple exercise which every one whether with an educational background of finance or not, can learn easily.
The stock analysis contains simple steps where an investor tests any stock on financial, valuation, business & industry and management parameters. You may read about the process of selecting stocks for investment in this article:
Selecting Top Stocks to Buy: A Step-by-Step Process of Finding Multibagger Stocks
Most investors can save themselves the trouble of investing in non-performing companies if they conduct personal due diligence before investing in the stocks.
2. Regular Monitoring of Stocks in the Portfolio:
Monitoring stocks in one’s portfolio is equally important as selecting good stocks for buying. Once an investment is made in stock, the investor should keep a track of a company’s financial performance, managerial decision, policy developments etc. so that she can decide about selling a stock when its business dynamics have deteriorated. On the contrary, she may decide to increase her investment, if the business performance of the company improves.
An investor should have a well laid out framework for monitoring his stocks. You may read about the process of monitoring stocks in your portfolio here:
How to Monitor Stocks in the Portfolio
Investors should monitor the business parameters of companies in their portfolio. It would expose weak companies in their portfolio and they can get rid of them at an appropriate time. Investors can use this money to invest in other good companies selected based on his personal fundamental analysis and avoid the opportunity cost of keeping money in non-performing investments. This would have help investors build a portfolio of good stocks, which could be held for decades to make long-term wealth from stock markets.
3. Avoiding Emotions to Influence Investment Decision:
An investor should learn that many times her emotions are at play, which makes her take impulsive buy/sell/hold decisions in stock markets. She should avoid ‘loss aversion’ while deciding to sell a poor company in the portfolio. She should avoid impulsive buying when she is not able to find any reasonably valued stock in a bull market to avoid ‘regret’ of missing the bus.
An investor should develop a checklist for stocks analysis and test every stock on these parameters before making a buy or sell decision. You may read about the checklist of parameters, which I use for stock analysis:
Final Checklist of Stocks Analysis
4. Selecting a Good Advisor:
If an investor decides to let go of her own analysis and hire someone else to manage her money, then she should check her advisor on the parameters of Custody, Conflict and Competence.
She should never transfer the money in the advisor’s personal account. The money should always be within investor’s account or with a trustee (like in case of mutual funds). Handing over money to an advisor, in a manner where the advisor can use it for any purpose, leads to the risk of Ponzi schemes.
She should check whether the advisor is getting commission from the sale of any financial product sold to her. Such an arrangement would exclude almost all of the financial advisors in India. However, it is a fact that most of the advisors in India have a conflict of interest. It is one of the main reasons for the prevalent misselling of financial products.
She should hire only a well-qualified person as her advisor. Financial advisors do not require a specific qualification and most of them learn on the job. Recently, specialized courses like CFP have shown their presence, however, the presence of certified advisors is still much less than the requirement.
If an investor does not want to conduct her own analysis before investing in stocks, then she would be better handing over her money to any good performing equity mutual fund. Most of the Indian equity mutual funds have beaten the market (Sensex) over last year with some of them providing returns in excess of 50%. My friend also could have avoided a lot of stress by investing in any good mutual fund.
Thus, we see that many of us make mistakes while investing, which are common to us all. Such mistakes cost us our hard-earned money as well as peace of mind. An investor can avoid such mistakes by conducting his own analysis before investing in any stock, regularly monitoring stocks in her portfolio and following a defined strategy of stock investments (a checklist). She should control her emotions from influencing her investment decisions. If an investor is able to take care of these paramount factors, then she can generate significant wealth from stock market investments over the long term.
You may read my review of the book: The 5 Common Mistakes Every Investor Makes & How to Avoid Them by Peter Mallouk, here.
P.S.
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Your Turn:
I would like to know about your experiences in the stock markets. How have you dealt with the stocks that have declined in value after you invested in them? What is your learning from staying invested in stock markets? What do you think the author and the readers should do to become better investors? You may provide your inputs in the comments below or contact me here.
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