Common mistakes and how to avoid them while making your investment plan

Financial planning is a numbers game. But individuals making those investment decisions are driven by emotions, impulses, and cognitive biases. An entire field of study – Behavioural Economics – is dedicated to understanding the psychological, social, and cultural factors that influence financial decisions. While no investment plan can be completely secure, becoming aware of common behavioural biases can help reduce risks.
Here are some behavioural biases to watch out for while planning your finances. Keeping these in mind while weighing your investment options can help you get the most out of your savings.

• Table of contents

1. Not starting early
2. Not having a goal
3. Not choosing the right portfolio
4. Recency bias
5. Trend-chasing
6. Loss aversion
7. FAQ

Not starting early

When it comes to an investment plan, a little can go a long way. If you’re just starting your career, or have many financial responsibilities, even a small amount set aside, through a systematic investment plan can help build a substantial corpus in the long run.

Not having a goal

A broad vision for the future is essential when you think of how to make investment decisions. Do you want to save for retirement? Are you building a fund for your child’s education? Or do you want some liquidity in the short term for travel plans and miscellaneous expenses?
For mutual fund investment, the time frame you’re looking at will influence the portfolio or type of fund you chose. For instance, if you plan to invest for more than 10 years, you can consider an equity-based mutual fund portfolio. This is because stock markets tend to stabilise and trend upwards in the long run but can be very volatile in the short term. However, debt mutual funds, which invest predominantly in fixed-income instruments such as bonds and securities, are likely to be more stable compared to equity for short-term investments. A hybrid portfolio, with a healthy mix of equity and debt, may be a good option for mid-to-long-term investments.

Not choosing the right portfolio

Mutual funds offer a vast scope for portfolio diversification. Depending on your financial goals and risk appetite, you can choose a mix that works best for you. Those who can tolerate higher levels of risk may consider an equity-based fund, while a debt-heavy one may be better for those who want low risk. You may also want a fund that invests across asset classes, such as equity, debt, gold, and real estate, to distribute risks and returns more evenly. There are several other permutations and combinations, including your investment horizon and liquidity requirements, that can help you decide which portfolio mix to opt for.
It is also advisable to check the performance of your mutual fund or funds at least once a year to see which assets are up or down. If required, you can switch to a different fund type, change your asset allocation, or opt for a different asset class .

Recency bias

One of the key investment tips is to avoid making long-term decisions based on recent market trends or headlines. This can lead to one of the most common blind spots in market-based investing: buying high and selling low. When the markets are having a good run, people tend to accumulate stocks (that is, buy when prices are high), on the assumption that the bull run will continue. Conversely, when markets at declining, investors tend to sell off stocks in a panic, on the assumption that the downfall will continue.
Financial experts warn against making impulsive decisions and suggest that over a horizon of seven to 10 years, stability is usually restored in the market

Trend-chasing

A recent tendency is to follow the crowd or jump onto the latest investment trend without adequate due diligence or assessment of your goals and risk appetite. A particular stock, crypto-currency or mutual fund may have had a strong recent run, but predicting the future based on past trends can prove to be a mistake. Another example of this may be that even though you have a low risk appetite, you invest in the stock market or a mutual fund because your peers are doing so.

Loss aversion

A common psychological tendency is to focus more on avoiding a loss rather than pursuing an equivalent gain. In the context of finances, this could mean that in an otherwise healthy market environment, an investor will hold on to a loss-making stock or fund for too long in the hope that it will eventually recover, rather than accepting a small setback and investing in something better.

Conclusion:
Psychological impulses, cognitive biases and emotions can have a big influence on investment decisions. Keeping these in mind can save investors from common errors. It is advisable to consult a financial advisor whenever possible.

FAQs:

What is the right age to start investment planning?

Although it is true that investments tend to grow in value the longer you hold them, the reality is that investing only becomes an option when you have disposable income that you can afford to invest for the long term. As the Chinese proverb goes, ideal time to start investing was 20 years ago, the second-best time is now, as long as you have the financial flexibility to begin.

What is the need to have a financial advisor?

A financial advisor should be your partner in helping you reach your financial objectives. The ideal financial professional not only has the skills to address your difficulties but also shares the same outlook on investment and life in general. The advantages of taking the extra time to select a perfect financial advisor will save you every time from making hasty decisions.

Do I need to regularly check my investment portfolio? And how often should I do it?

If you have a well-diversified portfolio, there is a good possibility that certain investments will rise while others will fall. The portfolio you constructed with a lot of planning will begin to seem very different at the end of a quarter or a year. Don't walk too far off the path! Check in on a frequent basis (at least once a year) to ensure that your assets are still appropriate for your situation and, more critically, that your portfolio does not require rebalancing.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.