SIX COMMON MISCONCEPTIONS OF INVESTORS

The world of investing can be cold and hard. Especially when you start overestimating your abilities. Unfortunately, many also hold on some misconceptions and tend to act under their beliefs and perceived abilities. In this article, we explore some of these misconceptions and beliefs which are harmful to the interests of the investors.

1.       BEING INTELLIGENT IS THE KEY TO SUCCESS

Intelligence is overrated. Studies have shown that being intelligent, by itself, has little correlation to success in life. You do not need to be from IIM or IIT to succeed as an investor. What matters more is, in the words of Warren Buffet, rationality and emotional stability. Interestingly he says that if you do have an IQ of 160 (considered very high), you should “give away 30 points to somebody else” because “you don’t need a lot of brains to be in this business”.

 

If one is not into researching stocks and directly investing, which is a full-time profession in itself, one really has no need for any intelligence. As an investor one needs only average intelligence to be able to understand and take personal finance decisions based on simple logic and reasoning and ignore emotions and personal biases from these decisions. As is often said, investing is simple but not easy. Intelligent people may often complicate things, including their portfolios and investment strategies. Intelligence often also comes as a hindrance in accepting that you made a mistake and accept contradictory views. Brilliant people may also get attached to their models and put a lot of thoughts into their actions. Temperament rather than intelligence is the key.

2.       INFORMATION AND NEWS IS VAUABLE AND ACTIONABLE

Do you really believe you have access to any undiscovered information that can impact markets? Do you think you can make use of this info and perhaps every important news as inputs to make investment decisions? If you do, how has it impacted your returns? The only ones who share information and peddle views, tips on them are those who either sell information or profit from the clueless small investors who trade on its basis, lured by the promise of high returns.

This belief also correlates with the earlier point. People with high intelligence often lack the temperament to control the urge to react to information and make changes to the portfolio every now and then. If only markets reacted logically, every economist and analyst would have been a millionaire. Over 95% of all what we read and hear is noise and bears no material impact on our returns, although it may have a negative impact if we intuitively act on them! The rest is what remains “may” warrant some consideration, factual or fundamental in nature or voice of the experienced investment gurus in market swings.

 MARKETS ARE FAIR AND CARE ABOUT TODAY

The efficient market hypothesis also known as the efficient market theory is a very common/popular theory on equity markets. It says that the share price always reflects all information and trades at fair value in the markets. This makes it almost impossible for investors to purchase undervalued stocks or sell stocks at inflation prices. This theory did help Eugene Fama an economics Nobel prize in 2013, unfortunately, though, it hasn’t really helped investors meaningfully.

Reality is far away from this rational theory which keeps running into irrational investors in the market. In reality, there are many different types of players in the market with different objectives – traders, speculators and investors. This makes it difficult for a small investor to estimate the real, fundamental value of any stock. The recent months we experienced once again that markets behave irrationally, at extremes. Wise investors need to look out for the irrationality of the markets to find opportunities and act in contradiction to the markets instead of believing blindly in what it tells them.

4.       NOT HAVING A PLAN IS NOT A BIG DEAL

There is a maxim used by traders in the market which very few investors may have heard of - “plan your trade and trade your plan”. While we are not in the business of trading, nothing stops us from learning from this maxim. What it simply says that before investing even a single rupee, we should have a clearly defined plan or strategy or an objective/purpose for investing at the very least.

Investors should have defined goals or portfolios that follow a strategy – the most ideal being the asset allocation strategy for retail investors. Having a strategy is what gives you an answer as to what to do in different market cycles. Effectively, you will be investing in your strategy and not the underlying products directly. It would also help you rebalance your portfolio periodically or during sharp market movements. Managing your portfolio manually is possible but one may not be able to consistently follow a strategy

  TOP PERFORMING FUNDS ARE THE GOOD BETS

Should I switch to top-performing funds? With rising awareness and easy access to investment applications, many investors feel that they can easily find top-performing funds and ask this question. Wouldn’t it be so easy for everyone if things were so simple? The real question investors should ask is ‘do top funds continue to outperform’?. The answer to this is that they often don’t.

Likely, a top-performing fund today may not be so two years later. Taking decisions purely based on historical returns is not a good idea. Most websites and mobile applications showcase ratings that are purely on these historical returns and do not consider many other crucial factors important for decision making. Some experts claim that only about half of the top-performing funds do better than average returns in the next year. It is a fact that chasing top performers can be harmful to your portfolio and this is what many new investors are now realising. The regulator, in fact, mandated the publication of the standard disclaimer - ‘past performance is no guarantee of future performance”.

6.       TIMING THE MARKET IS POSSIBLE

“Buy low sell high”. Sounds very exciting! Market timing makes for a great story and that is why so many investors are attracted to this idea. There is an underlying belief here in our ability to predict markets and actually even call out on market tops and bottoms. However, this strategy clearly falls apart under scrutiny. Markets can stay irrational for a longer time and can test the patience of a rational mind. The primary reason being, the markets are not efficient and not rational. We have seen so many market booms and busts, however, there is little evidence that anyone has successfully and consistently predicted them with definite time frames, including the top investment gurus in the world.

Research suggests that investors who buy and sell stocks during periods of market volatility may see lower returns than investors who stick with an established investment strategy. Studies in US markets have shown that investor would need to accurately time the market 74% of the time to earn more than someone who just stays in the index. Another study indicated that less than 50% of “market timing experts” predictions were correct. You can better toss a coin to get a better prediction. Trying to predict markets can leave your portfolio in a vulnerable state. A better strategy would be to simply follow a disciplined investment approach like SIPs and/or following an asset allocation strategy. Following this approach and sticking with it will leave you in a much better position to achieve your financial goals.

This article is an extract of our article published in September 2020 Digital newsletter