Making errors in investment can negatively affect your goals for wealth accumulation, impacting both your financial resources and the duration needed to achieve those goals. The initial measure to minimize the likelihood of such investment errors is to recognize the most prevalent ones.
Here are some of the most frequent investment mistakes encountered by retail investors which can cost them dearly:
1. Not establishing financial objectives before making investments
Financial goals represent the specific monetary achievements you aim to reach within a designated timeframe, such as saving for your child’s education, planning for a vacation abroad, preparing for retirement, or funding a wedding. By defining these goals, you gain a clearer understanding of the amount you need to save and invest consistently to fulfill your life aspirations. This process not only provides direction for your investment strategy but also aids in developing an optimal asset allocation plan that aligns with your risk tolerance, expected return, and investment horizon.
For example, while equities may exhibit significant short-term volatility, they generally outperform other asset classes and inflation over the long term. Therefore, for long-term financial objectives, it is advisable to invest in equity-related instruments to build substantial wealth.
Also Read: Investment Tips for Beginners: How to make the most of your investments
2. Mixing insurance with investment
The main purpose of acquiring a life insurance policy is to ensure that one’s family receives a replacement income in the event of an unexpected death. Therefore, it is advisable that the coverage amount of the life insurance policy be at least 10 to 15 times the annual income of the insured individual. Many investors tend to conflate insurance with investment, leading them to purchase endowment and money-back policies. These types of insurance products often do not provide sufficient life coverage and yield subpar returns, in addition to having limited liquidity. In contrast, term insurance policies deliver a higher level of coverage at a significantly lower premium.
3. Overlooking the effects of inflation
Numerous investors tend to overlook the effects of inflation on their financial objectives. Inflation diminishes the purchasing power of money, potentially resulting in insufficient funds to achieve these goals. Therefore, it is essential to consider historical inflation trends when determining the approximate investment amount necessary for your financial aspirations. According to financial experts, equities represent the most effective asset class for outpacing inflation while fulfilling long-term financial objectives, significantly outperforming both fixed income securities and inflation over extended periods. However, you must take into consideration your risk appetite before investing in equity-related products.
4. Getting swayed by emotions
Investors frequently allow their emotions, particularly fear and greed, to influence their investment decisions. Greed often drives them to increase their investments during bullish market phases, despite the fact that high valuations should raise concerns. Conversely, fear can prompt them to withdraw their current investments or refrain from making new ones during market downturns, even when equities are priced attractively. To promote disciplined investing, consider investing in mutual funds through Systematic Investment Plans (SIPs). SIPs foster a routine of consistent and automatic investments, enabling investors to take advantage of rupee cost averaging by acquiring more units at lower Net Asset Values (NAVs) during market declines.
Furthermore, establishing a ‘market-crash fund’ can facilitate lump-sum investments in equity funds during significant market corrections. This strategy may optimize opportunities presented by lower valuations and potentially accelerate the achievement of financial objectives with reduced contributions.
5. Failing to maintain a sufficient emergency fund
The primary purpose of establishing an emergency fund is to address financial crises and cover essential expenses that may arise during periods of income disruption due to job loss, disability, or illness. Consequently, this fund should be substantial enough to cover unavoidable monthly obligations, such as EMIs, SIPs, insurance premiums, children’s education fees, and rent, for a minimum duration of six months.
In the absence of an adequate emergency fund, individuals may find themselves compelled to liquidate long-term investments or take out loans at elevated interest rates to manage such financial challenges. Additionally, unexpected emergencies occurring during market downturns may necessitate the liquidation of market-linked investments at a loss. Therefore, it is crucial to allocate a sufficient emergency corpus to address your financial requirements during times of crisis.