Modules for Personal Finance
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7 Common portfolio management errors made by beginner investors
Have you ever observed a child who is learning to write the alphabets? Do they get it right on the first try? We’re pretty sure they don’t. It takes a lot of practice and of course, quite a few errors even, before they get good at writing the letters. In fact, it’s pretty much the same with all life skills - driving, learning math and perhaps even scoring a goal on the basketball court.
Drawing parallels, portfolio management is also learned over the course of some time. And as a beginner to this art, you may find yourself making more mistakes than you expected. But, don’t worry about that. We’ll throw some light on the common errors in investment management that beginner investors tend to make.
Get to know them well, so you can steer clear of these errors.
Not matching the investments in the portfolio with the goals
As a beginner investor, you shouldn’t just stop with charting out your financial goals. Your goals serve no purpose if you don’t back them up with the right investment options. Many beginners tend to think that investments, irrespective of what they are, will aid them in their pursuit of satisfying their financial goals.
However, this couldn’t be further from the truth. Only by matching your portfolio investments with your goals can you ever hope to satisfy them. For instance, if your goal is to save for retirement, you’d be better off investing in mutual funds and PPF, which have a long-term outlook, rather than individual stocks or T-bills.
Not creating a portfolio on the basis of risk appetite
Your risk appetite plays a huge role when it comes to allocating your capital across your portfolio. Most beginner investors tend to not factor in their risk tolerance level when creating a portfolio. This can prove to be a poor decision. For instance, it doesn’t make sense for a conservative investor to invest in significantly riskier options like small-cap companies now, does it?
So, paying heed to some solid portfolio management advice, it is a good idea to first do a risk analysis on yourself to determine your risk tolerance. Once you’ve done that, you can move on to building a portfolio based on your risk appetite.
Creating a portfolio of investments with inadequate research
Fundamental and technical research are powerful tools. Unfortunately, many beginner investors tend to skip the research and dive right into investing, particularly when they’re building a portfolio of companies’ stocks. This misstep can prove to be very costly in the future, because a company with weak financials may do well in the short-term, but may not be able to sustain in the long-run.
Adequate research can help you identify such glaring issues with ease. So, before you choose the stock of a company (or any other investment option, for that matter) for your portfolio, always make sure to perform adequate research. This way, you can, to a fair extent, gauge the current performance of the investment option, as well as its future prospects.
You may have heard a lot about this particular portfolio management advice. Diversification is a very important strategy that can help reduce your overall exposure to investment risk. Nevertheless, some investors, particularly the ones who are still learning the ropes, tend to build a portfolio centred around a particular kind of investment option alone.
For instance, look at 23-year-old Ajay. He works in a stockbroking firm and so, he’s inclined to invest heavily in stocks. That may be okay, as long as he balances it out with some less risky investments. Ajay, however, has invested 100% of his capital in the stock market. So, his investment risk just shot up tremendously.
On the other end of the spectrum, we have 30-year-old Rahul. He’s a very conservative investor and like his parents, he believes staunchly in the power of fixed deposits. The result? He’s put in 100% of his savings and capital in deposits. This may keep his money safe, but it lowers his potential to earn significant returns.
Both Ajay and Rahul’s investment portfolio could benefit from a little more diversification - both across investments and across sectors.
Going overboard with diversification
On the other side of the diversification coin, there’s another common error in investment management that beginners are prone to - diversifying too much. In a bid to ensure that their portfolio isn’t restricted to just a handful of investment options, some new investors tend to go overboard with diversification.
For instance, take a look at Deepak’s investment portfolio.
- Large-cap stocks: 10%
- Mid-cap stocks: 10%
- Small-cap stocks: 10%
- Debt funds: 10%
- Real estate: 10%
- Gold: 10%
- Fixed deposits: 20%
- PPF: 10%
- T-bills: 10%
You see how he has added a number of investments, each with just a minor share of his investment capital, just for the sake of diversification? This ends up diluting his portfolio a little too much, thereby lowering the potential of his investments to grow and deliver significant returns.
A good way to counteract this would be to diversify based on the financial performance and future opportunities presented by different investments. This would not only satisfy the goal of diversification, but would also keep the capital invested in the right growth drivers.
Not balancing the portfolio periodically
Portfolio management is not a single, one-time action. It is a continuous process. Many new investors might tend to think that once they have successfully constructed a portfolio, no interference is needed. However, that’s not true.
You need to regularly monitor the progress of your portfolio and may even have to make changes to its composition to accurately reflect your investment strategy. If one or more investments in your portfolio are underperforming, it makes very little sense to hold onto them, right? To keep your portfolio working toward your goals, you have to periodically rebalance its constituents.
Not seeking professional help when needed
As beginner investors, creating and managing a portfolio is not an easy task. Sometimes, you might require professional assistance. Unfortunately, many investors who are new to the investment scene tend to shy away from asking for help when it comes to portfolio management.
But, as you know by now, the stock market is a volatile environment. You might have to wade through tricky waters every once in a while. And when you do, professional assistance from dedicated portfolio managers can go a long way in helping you navigate to safety.
So then, that brings this module to a wrap. In our upcoming module - ‘Fundamentals of fundamental analysis’, we’ll be dealing exclusively with fundamental analysis of companies. You will get to learn more about financial statements and how to read and analyse them. So, stay tuned!
A quick recap
- It is important to match the investments in your portfolio with your goals.
- It is a good idea to first do a risk analysis on yourself to determine your risk tolerance. Once you’ve done that, you can move on to building a portfolio based on your risk appetite.
- Fundamental and technical research are powerful tools. Unfortunately, many beginner investors tend to skip the research and dive right into investing, particularly when they’re building a portfolio of companies’ stocks.
- Diversification is a very important strategy that can help reduce your overall exposure to investment risk.
- Diversifying too much can also be a poor investment decision.
- You also need to regularly monitor the progress of your portfolio. You may even have to make changes to its composition to accurately reflect your investment strategy.
- Professional assistance from dedicated portfolio managers can also prove to be useful for beginners.