Why investing in markets without knowledge can lead to losses

Lured by the stock market and several success stories, many of us want to dive right in and invest in the most lucrative stock. In our haste, we miss out on a few important factors. We do not realise the importance of understanding our financial needs or what we are getting into before we invest. Consuming all available reading material to get ahead with our investments, might not help us either as many a times we lack the basic information. Half knowledge, at times, can prove to be more dangerous than no knowledge at all.

Most Indians think of equities, stocks or shares as risky investments. This is precisely why, until a couple years ago, there was very little participation in the equity market. As this changes, we are seeing investors investing around Rs.8000 Crore per month through Equity Mutual Funds alone.

Equity, as an asset class, should be a key component of every portfolio as this asset class has the potential to provide the highest post-tax returns in an emerging economy such as India. Well managed Equity Mutual Funds are the best way for investors to participate in the Equity market. The proportion of equity in your portfolio can vary based on your overall objectives, returns needed for goals, time horizon, investments in other assets and ability to sleep well when Equity markets go up and down. Equity markets operate in bullish, bearish and consolidation modes. There are times where markets go up for an extended period of time, there are times when markets go down for an extended period of time by as high as 60% (individual stocks can even go down 95% or more), and there are times when markets are flat at particular levels or in a narrow range(consolidation mode).

Over time, markets have the potential to deliver 12-14% in line with long-term corporate earnings growth. Although equity returns over a period of 38 years have been around 16%, you should plan your savings and investments on the basis of a 12-14% equity return. Sure, you can make money in days and weeks, but you can quickly lose your shirt too. Hence, it is important that you never invest money that is needed in less than 3 years in equity.

When it comes to making equity investments, time and again investors tend to focus on the wrong set of parameters such as oil prices, stock prices, interest rate. You spend countless hours watching Business channels, reading magazines for hot tips, tracking the unknowns, which in fact, is not in your control. Before deciding on how much of your portfolio should comprise of equity, you need to take stock of our financial goals, time horizon associated with each goal and your risk appetite. This will help determine the returns you reasonably need to achieve your financial goals and make the right investment decisions.

When it comes to investing, to be a winner, you must make as few costly mistakes as possible. While a lot of people would like to believe that that are above making investment mistakes, there is no one in the world of investing who has not made a mistake. The key is to understand how to avoid making the costly ones. Understanding and managing risks is the most important part of this. Take too much risk and you might jeopardize your financial future with huge losses. Take too little and you jeopardize your financial future with returns barely enough to cover your lifestyle expenses.

It helps to periodically ask yourself these questions to determine if you are comfortable with your current risk level.

1. Am I losing sleep over the market fluctuations?

2. Do I worry about missing out on news related to your stock market investments?

3. Do I excessively worry about and track factors such as oil prices, stock prices, interest rates, inflation etc. that are not in my control?

If the answers to any of those questions is yes, then you have taken on more risk than you can handle.

When investing, it is important to remember that a lot of the factors affecting your investments are not in your control. But as investors, if we take investment decisions keeping our financial goal at the center, it is possible to secure a stable financial future.

The writer is CFA, founder, Happyness