Mistakes to avoid in equity investing

Many of your friends or relatives may recall their bitter experience in the equity market and may even dissuade you from entering it. But then, there were many others who made their money. If companies such as Infosys or Hindustan Unilever have grown to the size at which they are now, it is only logical that those who invested in them (not just the promoters, shareholders too) also built their wealth as the companies grew!

Your friends who complained about the equity market probably failed to follow some fundamental rules in the market. Here are three mistakes you would do well to avoid, if you wish to build wealth through the best delivering asset class in the long term.

Mistake #1: Going short term with equities and long term with deposits

For most of you who are allured by the high returns of equity in the short term, when the market is rallying, it is easy to assume that it is great to take short-bets in equities and instead build wealth for the long-term with fixed deposits. There begins the most inefficient way of building wealth. 

Let us first take the case of short-term investments done through equities. Had you invested in equities in late 2007 or beginning of 2008, you may have lost anywhere between 50-60% in equity funds in a year’s time. If your short-term goal depended on this investment, your goals would have gone for toss. Added to it, you may close your doors at this asset class, dubbing it as risky and unpredictable.

But the truth remains that equities have time and again shown to deliver over the long term. The 10-year or 15-year rolling returns of equities have never been negative.
Conversely, for long-term goals of say 10 years or over, such as children’s education, a typical investment route used by many is recurring deposit. An investment in an RD would be at 7.25% interest today for the next 10 years. If you consider the present education inflation (CPI tuition fees) of 7% to remain so in future, chances are that you will not save sufficiently for your goal (for a course that costs Rs 10 lakh today, even a Rs 10,000 a month of RD for 10 years would be insufficient) or you would be forced to save very high sums every month. This has been the case in the past. That is the risk that deposit poses — the risk of not beating inflation and delivering poor post-tax returns over the long term.

The ideal thing would be to save in equities for long-term goals and invest in deposits for near-term needs.

Mistake #2: Trying to time the equity market

Historical data suggests that retail investors typically enter markets in hoards when the market is in a bubble; be it in the peak of 2000 or 2007 or the short high of 2010 or the rally of 2014, only to hurt themselves either by a fall or be disenchanted by a flat market. And in a fall such as 2008, just holding on to your investment would not even have helped, had you invested lumpsum as there was a prolonged downturn. Yes, equity markets are volatile. It is possible that they drop by a huge amount after you invest. The only way to overcome the pain of such volatility is to invest systematically and avoid ill timing, deliberately or inadvertently.

Systematic investment is best done in a basket of stocks. If you do not have the time and resource, it is ideally done though investing regular sums every month in equity mutual funds. You also need to stay long enough to ensure that the market volatility has worked in your favour through rupee cost averaging.

Mistake #3: Investing all your money in a single bet

Do not put your eggs in the same basket. Do not invest in one stock or theme because it is the hot idea around. Investing big time in IT stocks before the Y2K bubble or investing in infrastructure or real estate before the 2008 crisis meant that your portfolio would never have fully recovered from the shock .

It is good to take a diversified approach to investing in equities, taking a mix of blue chip large-cap stocks/funds to provide stability and some high growth/midcap companies to provide some kicker returns. Taking excessive exposure to single sector or single stock can hurt you when the sector’s fortune turns or the stock is hit by unforeseen events the way it happened with Sathyam Computers.

Despite the cautions you took, if your stock or fund is moving southward and the prospects for such stock or fund seems low, it is best to exit by cutting your losses. Do not try to throw good money after bad. By doing so, you are missing out on better opportunities out there.

(The author is Head of Mutual Fund Research at FundsIndia.com)