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The Three Mistakes Of An Investor's Life

Not understanding how risk and reward go hand in hand is a surefire way to make long term losses on your hard earned money.

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Nearly all Investors have at some point in their lives made investment decisions they have regretted later. Here's a list of what can be counted as the top "three mistakes of an investor's life". Steer clear of these and you'll be setting yourself up for long tern investing success!

1. Not Understanding Risk & Reward
Before all else, it's very important to understand that when it comes to investing, there are no free lunches. Here's a convenient thumb rule to check your risk tolerance - for every percentage point of post tax return that you are aiming for above the risk free rate (the return on 10 year Government bonds), do you have the capacity to tolerate at least twice that number as a short term downside? For example - let's say you are aiming for a 15% per annum return - that's 7% more than the risk free rate of 8%. Do you have the capacity to tolerate a short term downside of twice that number (that is -14%), or will it give you sleepless nights and drive you to take rash decisions? If not, you'll be better off opting for lower risk instruments and settling for a lower return.

Not understanding how risk and reward go hand in hand is a surefire way to make long term losses on your hard earned money.

2. Buying On Euphoria, Selling On Fear

Your neighbor made a profit of Rs 2 lakh in the stock market. Your brother has just sold his property at a profit of 25 lakh. Your colleague's mutual fund portfolio has grown by 50% in the past year. These numbers are enough to generate a heady mix of regret and euphoria in your mind. Buying on euphoria is not a smart idea - one must be realistic and take rational, long term investment decisions based on sound logic and rational evaluation instead.

A mistake of comparable proportions is selling out or exiting based on fear. Words like "bloodbath" and "crash" are often heard during market downturns, and it's a natural mistake to exit your investments (or sell your real estate holdings or stop your SIP's) after prices have fallen, simply based on the fear that they might fall more. This may or may not be the correct decision - evaluate your decision rationally before taking a call. To borrow an anecdote from the investing great Warren Buffett - "I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful."

3. Not Doing Your Homework
Caveat Emptor is a popular Latin phrase meaning "Let the Buyer Beware". While it's good to have a trusted Financial Planner whose advice you have complete confidence in, it's equally important to confirm all relevant facts before you invest your hard earned money. It's both your right and your duty to thoroughly check for investment risks, past returns, fees, inbuilt loads and charges. In today's information age, it's become relatively easy to check for facts and arrive at a rational decision. It's better to do that in advance than to get saddled with a poor investment and regret it for years on end! It's also advisable to avoid buying Financial Products from friends or relatives in order to "do them a favor". In such situations, one almost never checks back to see if the investment is actually worthwhile, and this can lead to regrets at a later date.

Wishing you good luck with your investments!


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