Are you the worlds worst investor? Overconfidence bias and herd mentality are the biggest enemies of any investor. Overconfidence bias is a feeling that you know more than you actually do. Herd mentality simply means buying something just because majority of them have bought. Both these drawbacks are common to most naive retail investors. In fact, herd mentality increases your overconfidence bias. Imagine you bought something by chasing a latest fad and it went up. Think buying any FMCG stock in the current environment where defensives are outperforming cyclicals. If the stock does well, an investor may gain confidence in his stock picking ability. But effectively here he has fallen prey to a greater fool theory. Ignoring valuations and buying something in the hope that asset value will increase in future and you will be able to sell it to another person (read fool) is the essence of greater fool theory. Chasing fads and buying on advice which is fraught with conflict of interest is the biggest investing mistake investors could ever make. Buying dividend yield companies is another area where investors commit folly. Since dividends have sentimental value, investors become an easy prey to management gimmickry of depicting themselves as shareholder friendly. Most investors are unaware that stock markets are fraught with dividend bait companies. Such companies lure investors by paying high dividend for a couple of years even if their financial condition is poor. Think of a company paying dividend by raising debt. Buying companies simply on the basis of dividend yield is a recipe for disaster. Investors should assess the long term dividend paying history. Consistency in payments and the source of funding should also be seen. Apart from being lured into dividend trap, following trend is another concern for naive investors. Rewind back to 2010. Most infrastructure stocks were hot picks then. Infra story was sold in every nook and corner of Dalal Street. Thats because India had grossly under-invested in infrastructure. However, we know the performance of infra stocks since then. Anyone who bought then chasing the infra trend is sitting on huge losses now. This is another example of trend analysis going wrong. Buying on dips and increasing exposure to stocks without paying heed to fundamentals is another mistake which most investors make. Its called averaging. This happens when there is no proper asset allocation and financial planning in place. To sum up buying on patterns, chasing fads, timing the market and investing on hot tips are common mistakes investors commit. One should have the nerve to ignore such external noise. Following the basics like focusing on management quality, fundamentals and financials is the key. Also, one should be more stock specific and stick to his/her circle of competence. Another strategy is to approach a financial adviser if you are unable to take your investment decisions. What are the worst investing mistakes you have made till today? Let us know your comments or share your views in the Equitymaster Club.
Posted on: Wed, 29 Jan 2014 13:49:30 +0000
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