Over the past 20 years I have dealt with the financial markets. I have obviously met all kinds of people -- brokers, bankers, owners of brokerage houses, life insurance salesmen, relationship managers, and of course the guy who pays all the bills -- the 'investor'. Here is a summary of mistakes I have seen investors make. Of course it is not exhaustive, and investors find newer ways to lose money, but here it is anyway...
1. Trading and thinking this is investing
People buy and sell shares, mutual funds, etc. at a frenzied pace -- it is a fantastic way to make money for your broker, not for yourself.
2. Being too conservative with their money
Thinking that putting money in RBI bonds, PPF, own PF, bank fixed deposits is the best thing to do? Such people do not understand inflation risk, pre-payment risk, call risk, etc.
3. Being too aggressive with their money
Contrary to (2) category is another category which has read somewhere 'over long term equities give the best return' -- so they keep pumping money into direct equity without understanding portfolio construction, regression to the mean, etc. Such people do not understand that to finish first, you have to first finish! (I hope you like this quote, it was made by Warren Buffet, not yours truly).
4. Bull headed
I know a friend who pounds the treadmill. At least 10 trainers have told him to run softly, but he does not listen. I really pity his wife and colleagues -- this guy is completely bull headed. There are some people who will not make mid-way correction. As an example I know this guy who had bought some shares of Patheja Forging, Shaan Interval and Silverline. He refused to sell -- because he had read that 'equities are for the long run' -- all the promoters of these companies are absconding! Please remember to make money in equities you need to invest in a good portfolio (like HDFC Top 200), choose a good fund manager (like HDFC Mutual Fund, DSP Merrill Lynch), invest regular amounts (SIP) and hold for a long term (I like 10 years, if not more). That will make money for you.
5. Completely wrong asset allocation
Too much of debt for the long term or too much of equity for the next quarter! Investing in equity funds so that money can be withdrawn to pay the next EMI! Both are BS!
6. Trying to time the market
I have no clue why smart, intelligent people believe they can time the market. The reasons that I can think of is the pay off is so high, that people forget the extremely low probability of getting it right. Will do a detailed article on this alone. Promise.
7. Portfolio construction nightmare
People pick some stock somewhere because some aunt or uncle told them. Then they start believing it is a portfolio. I also have a tough time convincing my very smart editor why a portfolio is just a dhobi list, and not a portfolio. Most times she agrees with me, though reluctantly.
8. Handing over to a lousy fund manager
Banks, mutual funds, self help sites, life insurance companies, portfolio management services -- call them by any name they are just a mafia out there to make money. Most retail investors should be happy with an index ETF, a savings bank account and term life insurance. However we (yours truly included) spend hours, days, years on analysing past data to see how the market will work tomorrow. Sometimes when we get it right by luck, we pat ourselves by calling it skill. Vow! the world loves a winner.
When you hit a couple of home runs (as the Americans say) you tend to believe that you will contiune to hit home runs regularly. This is true for most of us -- we attribute our recent success as our creation and therefore we think we can repeat it -- this is caused by a big portfolio destroyer -- overconfidence.
10. Excessive activity
Mistaking activity for 'sensible' activity isa common phenomenon. The only beneficiary of this is the broker. To encourage this, brokers use TV channels, technical analysts, etc. If there is some software which tracks the brokerage paid to your broker/ advisor for dealing in shares you might be surprised at the amount you have paid.
Illustration: Dominic Xavier/Rediff.com