How To Avoid Making Big Losses in the Stock Market
Amar is a CFA Charterholder and CFP, having over 20 years of experience in IT and Financial Services. He is very passionate about spreading financial literacy and has authored four bestselling books on Personal Finance.
17 Jul, 2018
Raj Mehta, 36, was a risk-averse investor till September last year. Then, the stock market lightning hit him. Historical highs every month in the mid and small cap indices left him completely flustered. While, his friends were boasting of increase in wealth every day, he was only locked into fixed instruments and getting returns of a measly 6-7% a year. Even his wife started complaining that he was being too conservative. Then, Mehta decided enough was enough. He approached a broker recommended by his colleagues, went through the entire process of filling up a form and even opened a demat account. In less than a week, Mehta was all ready to enter the stock market. His broker also gave him a lot of attention and tips. By October 2017, Mehta had invested over Rs 5 lakh and his money grew by over 20% by January 2018. Now. Mehta was more clued on to the stock market than he was in his own job. However, in his focus to make money; he forgot one simple thing – risk.
He had taken out most of his money from his safe investments. This meant that while earlier his asset allocation had mostly debt instruments, now it was heavily tilted towards equity. His strategy was to make money and lots of it. Mehta’s portfolio was no longer risk-averse, but highly risky. In fact, in the greed for higher returns he ignored investing in large caps as the returns were ‘less enticing’. Though he was advised by a few that such a skewed position could turn against him, he was not ready to listen. His logic: “I have lost too much in the years I stayed away, now I need to make up for all that loss.” Mehta, in his attempt to make up for lost time, went more aggressive in January 2018. And why wouldn’t he? All his mid-and small-cap stocks were hitting the upper circuit daily. He like many others felt the markets would go up further. But, as things stand today, post the Union Budget, the mid and small cap indices have followed only one trend: down-wards. Mehta’s stocks today are down by a good 50-60%. His gains have been completely wiped out. He stands undeterred though. He reasons out with his wife that -“This stock will certainly go up and I will buy more of this stock at these levels. You know, my average costing has gone down substantially”. Sounds great, in terms of, theory, but there is a lot of difference between averaging a blue-chip or mutual fund. The theory falls quite flat when we are discussing the mid and small-cap segment. A rather common story, when we look for investor behaviour in the stock markets.
Here are a few common mistakes which all investors make:
- Not admitting a mistake
- Making investments without understanding what you are investing in
- Embarking on a financial journey without a road map in mind
- Not diversifying your portfolio
Ego, for one, should have no place while making investments. For instance, if you have made a lousy investment, recognise and rectify it. Sell it completely, if it is indeed a dud investment. But quitting the market entirely is not a great solution. Every market has good, average, bad and trader-driven stocks. And like everything else, good investments survive the market mania.
The biggest mistake Raj Mehta made was to invest in the stock market without understanding how the markets work. Influence by peers and greed for high returns made him jump into the equity markets without understanding how the markets work and how to choose an investment avenue. IT is important to have an understanding of the various investment avenues and what are the risks involved with each.
Making investments without considering one’s overall financial situation and how various components such as cash flow, liabilities, insurance (life and non-life), investments, retirement, tax and inflation would fit into it. Keeping your financial requirements and goals in mind will help you chart an investment plan that is ideal for you. Having a goal in mind also helps you avoid major mistakes when it comes to investing.
In this fast-paced life most of us neither have the time nor the expertise to make investments. Further the number of products and investment avenues makes it more difficult to decide where to put your hard-earned money. So, we often end up buying stocks recommended by friends and family. Instead of purchasing stocks without any knowledge, it is better to opt for mutual funds that provide you the benefit of diversification and at the same time mitigate your risk.