How to avoid mistakes & make safe investments

Yet another fabulous year for the Indian stock markets comes to an end. Though the year has been the most volatile of the last three years, 2006 has several records to its credit namely the five different index levels of 10000, 11000, 12000, 13000 and the recent 14000-Watt Kiss. Despite the rollercoaster ups and downs like the ones in Disneyland, the Sensex and Nifty have delivered handsome returns of 43.35 per cent and 36.47 per cent respectively.

As we usher in the New Year, it is time to understand the mistakes of 2006 some of which tend to be perennial and try not to repeat the same in 2007 for our long-term financial well being.

Looking at the stock market for making quick bucks just because your neighbour or friend has.

Just because the Sensex has delivered 32 per cent returns in the last 5 years and some of the best funds in excess of 60 per cent does not mean that future returns will be similar.

Don't just focus on the last 5 years but also look at the last 10, 15, or 25 years of performance across various timeframes. Try to understand the realities of the stock markets and you will figure out whether there is any mismatch between your expectations and what the equity markets can deliver.

Contrary to popular belief, stocks are long-term wealth creation instruments. But, most of the people use them as short term instruments to make quick bucks and when the tide turns against them, they swear never to look at equities again.

Some people religiously follow each and every piece of investment wisdom available through TV, print media and believe activity is the name of the game. Investing in the stock markets on the contrary is not a game or a contest; it is a continuous process over one's lifetime.

Leveraging or borrowing to invest

"Borrow at 13 per cent for 1 month and invest in IPOs, or tips. I made 50 per cent by dabbling in futures in 2 weeks. My wife earns Rs 10,000 every month by trading her account and she has just put in Rs 300,000, rest is margin money provided by the broker " were some common talks heard in 2006.

Because of the tantalising returns, it is very difficult to control your sanity levels and one might be considered guilty of committing a sin of not using exotic derivatives or leveraging your portfolio or borrowing to invest.

Some people learnt the hard way that using leverage can get you to lose more than 100 per cent, IPOs can list down 40 per cent on Day One and a lot of IPOs of 2006 are still way below their offer price.

This year might or might not see some sharp corrections but the probability of intermediate corrections is on the higher side. So for your peace of mind and prosperity, do not leverage or borrow to invest. Understand the risks associated with it and only bite what you can chew and digest comfortably.

Believing nonsense

I often come across ads which state, 'invest only Rs 50,000 and earn Rs 500,000, Intra Future Short Term Tips' to tips such as 'Ye Stock 3 Months main Double hone wala hai'.

In bull markets you will come across plenty of such nonsense, which you can comfortably ignore. On the institutional side, everyone from insurance companies, banks, brokers (commodity, equity), art funds to mutual fund houses have been coming up with a deluge of offerings with everyone eyeing for a share of your wallet.

Recently I came across a ridiculous ad from SBI Mutual Fund stating "Best of all the 4 regions working for you". Though this fund house has some of the best performing schemes of the last 3 years, it is shocking to see schemes being packaged and marketed like FMCG products.

This is unlikely to go down in 2007 with several insurance, asset management companies / mutual funds, private banks waiting to make a big bang entry into the country. So ignore the noise.

Timing the markets

Timing the markets is one elusive strategy yet millions of people aim to do it and many claim to have done it. Whether it's the technical analysis or the fundamental analysis or a combination of both, getting your entry and exit right is the most difficult to achieve.

This has been amply demonstrated to people who tried to do this in 2006 and will again be proved in 2007. Market ups and downs happen in very short spurts of time and we have seen in 2006 that even a 1000-point fall is likely in a day or so.

There is no man or woman in the history of investing who has been able to do this consistently day in and day out and I doubt whether going forward there will be anyone who can achieve this impossible feat.

The difference between investing at the highest and lowest levels of the Sensex every year from 1979-2004 is only 1.8 per cent. So don't fret whether you are investing at the highest level or lowest level, just do it systematically every year.

Overconfidence or pessimism

Everyone likes to talk about their success but very few people like to talk about failures or even admit them. Overconfidence and pessimism are two sides of the same coin. First four months of 2006 saw a lot of overconfidence only to be followed by many months of pessimism.

The year is likely to witness similar emotions depending on whether the index goes upwards, downwards or stays between a narrow range.

A person I knew during the technology boom believed that he had the Midas touch that most of his fellow equity investors of this country did not. He used to track and trade on every market move and boast of his winners but never talk of his losers. The longer he kept at it, the more overconfident he grew. That's because obsession over the market made him believe in his ability to spot future winners. He made increasingly aggressive bets, which sooner or later were bound to explode and this is exactly what happened. He later on became so pessimistic that he stayed out of the market even during the upturn from 3000 to 10000 only to enter in at 11000.

The stock market will make even the most adventurous person humble and you would excel in investing by understanding this reality.

How to avoid mistakes:

Make a New Year resolution to first and foremost spend some time thinking about your future goals and writing them down on paper. Writing your goals on paper have the power of making them a reality. Or best yet read the book Think and Grow Rich by Napolean Hill. Yes you read it right, the key is to think because we live in a world of 'Thinking DEFICIT ORDER' and thinking would certainly take you one step closer to rationality, which is an important ingredient in the world of investing.

Keep yourself level headed in 2007 and have reasonable expectations. The key is to exercise self-control, and you can get this to work for you simply by understanding yourself a little better. Socrates said "Know thyself is the key to Human advancement" and this statement takes the cake for its relevance and importance to how we understand ourselves think and act when it comes to equity investments.

Do a financial fitness checkup by looking at your overall asset allocation, products, time horizon, return objectives and risk tolerance.

Finally prepare an investment policy that will form the basis for your buy and sell decisions. The purpose of a written plan or a policy is to help you prevent costly mistakes, help you achieve your goals in life, providing comforts during very stressful moments while at the same time enjoying your journey called life.

Most people spend more time planning their vacations, deciding which car or plasma TV to buy, than planning their finances. It is beyond comprehension why people behave in this fashion yet this is one of the important areas that will determine your overall financial net worth.

An article published in Fortune Magazine in 1999 described a study that found investors who made written plans by the time they were 40 wound up on an average with five times as much money by age 65 as against those who didn't have written plans.

Keep an eye on the mistakes outlined above and ensure that you profit from them. A wise man said, "The best time to buy stocks was Yesterday. The second best time is NOW. View corrections in the market as great buying opportunities and do not miss some of the ones you will get in 2007.

The author is a practising Certified Financial Planner. He can be reached at amar.pandit@moneycontrol.com

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