5 mistakes that investors make with their stock portfolios
This article makes you aware of classic behavioural mistakes with stock investing and shows you the right way to safeguard against each.
5 mistakes that investors make with their stock portfolios
Posted on 27 Oct 2024
Author: Sayan Sircar
8 mins read
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This article makes you aware of classic behavioural mistakes with stock investing and shows you the right way to safeguard against each.
📚 Topics covered:
- Mistake 1: Adding stocks without adequate research
- Mistake 2: Acting due to Fear of missing out (FOMO)
- Mistake 3: Investing on borrowed conviction
- Mistake 4: Not selling at the right time
- Mistake 5: Thinking that you have an edge over other investors
Mistake 1: Adding stocks without adequate research
Researching which stocks to buy/hold/sell is a full-time job if you want to do it right. It is not a hobby and should not be attempted without full-time formal training (an MBA Finance degree, CFA Institute certification or equivalent) or access to a research team and insights due to direct interactions with company management.
Already, there is enough proof that active portfolio managers do not beat equal passive index funds. Why would an individual investor analysing stocks part-time with a day job expect to make more returns than professional fund managers?
Instead of buying stocks directly, most investors will be better off with:
- focusing on their human capital to increase their income so that they can invest more year-on-year: Your human capital, not investment returns, is your biggest wealth creator
- investing in broad market index funds: What are the best index funds for new investors in India?
Related:
How easy is it to double your portfolio?
By not devoting the required time to analyse individual stocks, you are trying to take a shortcut and apart from blind luck, that will not work out consistently.
Mistake 2: Acting due to Fear of missing out (FOMO)
Fear of missing out (FOMO) kicks in when you see everyone (friends, colleagues, relatives) around you, especially those whom you did earlier consider to be savvy investors, telling you how much money they have recently and in the past as well, have made with direct stock investing.
Three cases of FOMO derail a careful investor’s portfolio:
IPO flipping
IPO flipping is something many retail investors do to make money by applying for IPOs and selling it on the day of listing to make money due to listing gains.
Bull markets are the right time for companies to raise money via IPOs. Unfortunately, there is no guarantee that there will be listing gains. Lack of listing gains converts short-term flippers into long-term buy-and-hold investors.
Investing in penny stocks
The potential of making a lot of money with a small investment in penny stocks attracts many investors looking to make a quick buck. Unfortunately, given the information asymmetry of operator-driven stocks end up trapping many retail investors in the worst case. In many other cases, their stocks fall more than the market in a down market which causes unnecessary stress of regularly monitoring the portfolio.
Ultimately, penny stock investors should internalise the fact they are buying lottery tickets with the same risk/return trade-off that lottery tickets offer. If lottery tickets did create wealth, there would be a lot less.
It is easier to make money in a stock market than buying lottery tickets: Why the stock market in India is not a casino?
Buying stocks at a market high
The mainstream media (like newspapers and talking heads on business news channels) try to gather more eyeballs by constantly highlighting best-performing stocks, sectors and funds. This constant bombardment of news leads to many investors entering stocks once they have already run up. A classic example of overheated stocks is New Fund Offerings from fund houses in the latest hot stocks. Investors will almost guaranteed to get lower returns entering high-valuation stocks after the run-up has already happened.
A good example of this is the large number of defence stock NFOs that took place after June 2024 when these stocks had already rallied: The NIFTY Defence Index has risen more than 6x in 6 years. Should you invest?
At the time of writing on 27-Oct-2024, three Defence Sector mutual funds (from Groww, Aditya Birla and Motilal Oswal) are trading at 10-20% below their NFO price.
Mistake 3: Investing on borrowed conviction
Every time you invest based on someone else’s recommendation, it is a case of investing based on borrowed conviction. Borrowed conviction implies limited or no research done before investing. This case covers investing based on tips and from names casually mentioned by others.
This is a problem because you will, quite naturally, become indecisive as soon as the stock moves due to a lack of confidence in the original purchase decision. You also don’t know if the person giving you the recommendation is an actual expert in stock analysis, is just pretending or is generally clueless. A more malicious case, that happens more in operator-driven penny stocks, is pumping up the stock via TV and social media (YouTube, Telegram etc), which drives up the price when the operators exit at a good profit.
Borrowed conviction - stock rises
If the stock rises, the right answer can be to invest more if the investment thesis for the stock is solid. However, the investor might not wish to invest more, unless there is FOMO, since they are not sure if the stock will keep going up.
Borrowed conviction - stock stays flat
Another problem happens when you have invested based on someone’s recommendation: the stock does not go anywhere for some time. Then you are confused about whether to buy more (since the stock has not risen), sell some (since other stocks are going up) or do nothing (which leads to lost opportunities)
Borrowed conviction - stock falls
This is the worst case: you heard about a hot stock on social media, invested some money and then that stock fell.
Ideally, if you had done your own research, you would know if you should average down, exit based on either stop loss or change in the investment thesis, or hold based on the future prospects of the stock. Since you have not done any of these, it causes unnecessary heartache.
Mistake 4: Not selling at the right time
Direct stock investing implies revisiting the stocks in your portfolio regularly to ensure that they are still good stocks to invest in.
Depending on the number of stocks you have, and the required review frequency (once a quarter, once a year, once every five years etc), that would mean a good amount of time and effort: reading annual reports, equity analyst research, checking news, sector reports etc.
Any lack of effort here might lead to one of the worst mistakes that any investor can make: not exiting on time. A stock need not fall in price always to make it a sale candidate. If the stock is not performing as well as its peers and the broad market in general, it should be reanalysed and sold without delay.
Mistake 5: Thinking that you have an edge over other investors
The world of investing has changed drastically in the last 20 years due to the advent of the Internet and the free availability of data. While it has made it easier to perform both fundamental and technical research on a stock, it has removed the earlier problem of information asymmetry that existed in the pre-Internet era. That, coupled with 24x7 media has removed any edge that one retail investor has over another.
If we therefore assume that retail investors trading with each other are doing trades with random chances of success, it becomes worse if the counterparty of that trade is an institution. Unlike retail investors, asset management companies, investment banks and hedge funds have more money, access to expensive databases, the ability to talk to company management and the rigour of past processes that will make any retail investors competing in the same market have the same result of Sachin Tendulkar batting competitively in a gully cricket match.
Related Articles
- How to Avoid Losing Money in Indian Stocks: 2 Proven Strategies for Long-Term Success
- 12 mistakes that interrupt compounding: what to do instead
- How to balance FOMO and loss-aversion in the case of foreign RSUs?
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