“Experience is making mistakes and learning from them” -Bill Ackman
Making mistake is step towards learning, a proof that you are trying. We all have made some in the past and will make in the future as well. Investment related mistakes are no different. However, there are some very common mistakes that can be avoided by using common sense and some knowledge. Some of the most common investment mistakes are explained below, which, if avoided, will boost your chances of investment success.
Buying Greed, Selling Fear
It is the most common mistake made by investors. What makes investors buy rising stocks and sell falling ones? There are psychological reasons behind it.
Fear of missing out
When you see others making money buying stocks, you think it is the right time to buy. When someone talks about making a killing in the market buying a certain stock, fear of being left out is what forces investors to buy.
The cure of this “disease” lies in a quote of Warren Buffett,
“Be fearful when others are greedy and greedy when others are fearful” -Warren Buffett
One of the sure shot ways of making money in stock market is to have a contrarian approach. As long as the fundamentals of a company are intact, buying a stock at low price gives you margin of safety, which improves your chances of making a decent profit in the long-term.
Confirmation bias
Belief is perception of masses, and it is this belief that guides many decisions in our lives. If a stock is commonly believed to do well in the future, we start believing it is a great investment. While this may seem to be proved right in the short-term, in the long-term, a stock performs when the business behind the stock performs well. As Warren Buffett Says:
“If a business does well, the stock eventually follows”. -Warren Buffett
Instead of looking just for popular stocks, an investor should always look how well the business behind the stock is performing. Any stock that rallies without justifying fundamentals, is destined to fall. As Warren Buffet says:
“The dumbest reason in the world to buy a stock is because it’s going up.” -Warren Buffett
Buying what looks cheap
Common sense tell us that a cheap stock offers great bargain. Then how can a cheap stock be a poor investment? An investor must ensure that a cheap stock also has value. For this, it is important toanalyze fundamentals of the stock. (Learn “How to analyze fundamentals of a stock?) If the company has strong fundamentals, but stock price has corrected, it’s a bargain with value, and an investor should consider investing in such stocks. If the stock’s fundamentals are weak, it should be avoided. Buying high debt companies:
A company’s debt levels are measured in relation to equity using debt to equity ratio. By using this ratio, investors can determine the debt levels of a company compared to its equity capital. Higher debt to equity ratio means company is largely financed using debt.
“You can’t be in debt and win. It doesn’t work.” -Dave Ramsey
A company with high debt has to service it by paying interest. High debt means majority of company’s profits are used to pay interest leaving very little profit in the hands of the company. Another risk high debt companies face is rise in interest rates. If interest rates rise, company either has to pay more money as interest, or run the risk of defaulting.
An investor should always be cautious about how much debt a company has. Even if it is making great profits, high debt can eat a business’s entire bottom line, leaving almost nothing in the hands of the shareholders. In short, high debt companies are not very investor friendly, and should be avoided.
Trading too much/Stock juggling
When you buy and sell stocks too frequently, you make your broker rich. Day trading, or trading (that is buying and selling stocks) too frequently not only costs you in terms of brokerage, it is not so tax friendly too. When you trade stock for short-term, you have to pay a big chunk of your profits as tax. On the other hand, capital gains from stocks held for long-term (one year or more) are tax-free, plus you also get the dividend, which is also tax free .
Another disadvantage of trading stocks is that markets are highly unpredictable in the short-term. It’s hard to predict, with certainty, how a stock is going to behave in the next day, week or month. Due to this uncertainty, short term trading becomes risky and more speculative in nature.
Investing on stock tips
Ace investor Rakesh Jhunjhunwala says:
“You cannot make money on borrowed knowledge” -Rakesh Jhunjhunwala
Financial advisors, brokers, market experts get paid upfront for providing stock tips. They get paid irrespective of whether you make or lose money. Investing on stock tips is exactly like following an astrologer’s advice, both of them have no way to predict the future with certainty, but they get paid irrespective of whether you sink or swim.
Conclusion
The best way to invest in the stock market is to do it yourself. It requires lot of patience, discipline, and independent thinking, but its the best and the most fruitful way to make a passive income.