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How to avoid the mistakes of 2005 in 2006?

Hemant Rustagi outlines the five most common mistakes in 2005, that lost money for investors. Avoid repeating them in the new year.



The year 2005 was quite rewarding for equity investors. Those who believed in equity as an asset class reaped rich dividends. An average annual return of 56% by diversified equity funds testifies this. While there is nothing sacrosanct about the past performance, the fact is that equities have always performed better compared to other asset classes over the longer term.

Equity investing, however, not only requires constant monitoring of portfolio but also diverse approaches. No doubt, it is quite common to see investors making mistakes both while investing as well as redeeming. I am sure the year 2005 was no different. Let us analyse some of the situations that investors may have faced and also discuss the appropriate ways to tackle these situations to a disappointments in future. (Read more - Some Do’s and Don’ts of investing)

Stayed away from mutual funds

There are a number of investors who have been investing only in the traditional investment avenues over the years and would have done the same last year. Obviously, they need to rethink their investment strategy. The falling returns from these instruments as well as abolition of Section 80 L have definitely made a strong case for trying out potentially more rewarding investment vehicle like mutual funds. Besides, mutual funds also score much better on the criteria of liquidity, variety, flexibility as well as tax efficiency. Moreover, open-ended mutual funds allow investors to follow a disciplined approach of investing regularly as well as begin an investment programme with as little as Rs 500. (Read more - How to get the best out of MFs at these levels?)

Remember, equity should form an integral part of any portfolio designed to achieve long term objectives. However, the extent of equity exposure should ideally depend upon what one can afford financially and emotionally for the long term. Investing in mutual funds rather than direct in stocks has a number of advantages. Firstly, it is a lot simpler as there is only one price to follow instead of several. Secondly, one doesn’t have to make a decision about which companies to invest in. Thirdly, as an individual it is unlikely that one would have the resources or the knowledge required to research companies and keep track of the developments. (Read more - MF investing: Failproof strategies for uncertain markets)

While it is always advisable to begin investing early as the power of compounding makes a huge difference to the returns one gets over time. However, it is never too late.

Booked profit too early

With any investments there are two key decisions to be made. The first is when to buy and the second is when to sell. Obviously, the difficult one is knowing when to sell. No doubt, sometimes seeing the market touching dizzy heights one can have a mixed feeling of fear as well as excitement. In times like these, one may end up booking profits too early or redeem the entire equity holding. (Read more - Should you sell your fund now?)

While booking profits periodically is absolutely essential, relying on the market timing to do so may not be a smart thing to do. Considering that the stock market went from strength to strength during 2005, those who exited completely may have missed out on the varying degree of gains depending on the timing of exit. Therefore, one needs to follow a proper strategy to book profits. The right way to book profits is by way of rebalancing the portfolio to bring the asset allocation back at the original level. This will ensure that one remains invested in equity at all times. Besides it works very well even in a falling market as rebalancing ensures entry at lower levels.

Invested only in top performing funds

There is always a temptation to invest in top performing funds. However, considering the performance of mid-cap funds in the year 2005, anyone who followed this strategy may find these funds forming a substantial part of his portfolio. (Read more - Investment strategies for the risk averse)

While mid-cap funds have good potential, they should not be the frontline mutual fund investment and should not have a disproportionately high weightage in any portfolio. The 'bread and butter' funds so to speak, should be the diversified equity funds, with mid-cap funds at the next rung.

Discontinued SIP in a falling market

A Systematic Investment Plan is the best way to build up capital over a period of time. However, it requires a discipline to continue irrespective of the state of the market. There are investors who get panicky whenever the market witnesses a fall and get tempted to discontinue the SIP. However, the fact is that an investor who invests through SIP benefits in a falling markets as he gets more units for the same amount. Therefore, one needs to carry on and reap the benefits in the long run. (Read more - 7 reasons for SIP in a booming market)

Invested only in New Fund Offerings

A lot of investors have developed a special liking for New Fund Offerings (NFOs), irrespective of what they offer. The common perception is that by investing in a NFO at par value, one improves one’s chances of getting better returns. No wonder, whilst almost every NFO attracts large number of investors, some of the existing schemes with consistent and impressive track record, struggle to attract new money. Clearly, there is a need for investors to rethink their strategies of investing in everyone NFO.

It is important to know that the performance of a scheme depends on the quality of the portfolio, its exposure to various industries and segments of the market i.e. large cap, mid-cap and small cap as well as the strategy of the fund manager. Therefore, the logic that investing in a NFO guarantees success is completely unfounded. Besides, if one doesn’t analyze the features of the scheme, one may end up having over exposure in a particular asset class or segment. (Read more - New Fund Offer: 5 points to note before you invest)

On the other hand, if the scheme in question has some compelling features or invests in instruments that one can’t do directly, it definitely makes sense to consider investing. In other words, one should invest in those NFOs that fill the gap in the existing portfolio or widen one’s investment universe.

It will not be wrong to say that to be a successful investor on a consistent basis, one need to invest carefully and systematically in instruments that suits one’s risk profile and investment objective. Besides, it helps to develop strategies for investing and redeeming and test them from time to time to ensure that one is on track to achieve one’s investment goals. If one does so, the success is guaranteed.