Sometimes just avoiding a bad investment better than making good investment. If you don’t understand a great investment, better stay away rather than losing money due to lack of knowledge.
So often I come across people always curious about what is the next big investment opportunity and wanting to invest in it, even when they know they can’t handle it or will not be able to manage it. I always end up trying to convince them to look at avenues which they can understand. Their argument is if the investment gives better returns it is worth investing, knowledge will come as you start doing something. While this argument is partially true, that knowledge comes when you start doing something; the issue is that with investments that you do not follow, the knowledge may come only once you have made substantial losses. It makes a potentially good investment, a bad investment, something that needs to be avoided.
To understand better, consider a scenario where you want to start investing in equity and you know that direct equity has potential to give better returns than mutual funds and you opt for direct equity, that is you buy shares of companies based on some research, tips, gut feel or based on analysis and projections from financial channels and gain confidence that you ‘know’ what you are doing. Cool! But some weeks down the line you see your equity investments not doing what they were supposed to. You switch back to the same finance channels and see those same experts giving their opinions of the possible factors. At this stage do you understand that? Do you know exactly what the experts are talking and what the future will hold for that company? You may stick to it for too long and still find it not giving you as much returns as expected. This makes a bad investment decision which should be avoided.Photo courtesy: FreeDigitalPhotos.net via David Castillo Dominici
In the above scenario, both Mutual Funds and Direct Equity belong to the same asset class – Equity which is a great investment for the long term in the sense that it will give higher returns compared to most other asset classes. But it didn’t happen in the above scenario for you. A good investment turned bad investment because you lacked the knowledge, proper understanding or couldn’t manage it on your own. The same amount of money you spent on buying shares, had you invested in an SIP of a fund that has given consistent returns over the past 10 years would have yielded better returns in the long run and wouldn’t have eaten away your investment like direct equity did. The reason is while you may understand direct equity; you may at times not be able to manage it. There are times you need to sell and book profits or at times sell to cut down your losses. For this you need active managing of your investments and regular monitoring. Mutual Funds have fund managers responsible for this and hence you need to understand the function of a Mutual Fund, while the management part is taken care by them.
Another example where certain investments can go wrong and eat away your corpus if you do not understand it is your investments in products like ULIPs. Most of us have at least one ULIP, a policy which gives you life cover as well as market based returns. These policies are tricky and if you cannot follow them, they are too expensive and will give negative returns for a long period of time, at time for 4-5 years or even more, before you finally realise your mistake and surrender the policy; again, an example of a bad investment decision that could have been avoided. If you need life cover, go for term plans, it will save you money as well as give you relevant sum assured. The remaining money you save on the premiums, you should invest in PPF, Debt Funds and some in Equity based Mutual Funds for better returns.Photo courtesy: FreeDigitalPhotos.net via Vichaya Kiatying-Angsulee
If you do not understand certain products or are confused about the purpose of investments that the investment product is offering you, please stay away. Even if the product is great, your lack of knowledge and understanding can easily make it a bad investment decision. If you do not understand stock markets, opt for mutual funds, if don’t like the risks associated with equity mutual funds, opt for Debt Mutual Funds or Fixed Maturity Plans. If all this is too complicated to your mind, please go for Traditional Investments like Bank Fixed Deposits, Recurring Deposits, and PPF, in fact PPF is a great risk free, tax saving investment that should be opted for in any case.
At times the returns from investments like FDs, Recurring Deposits etc maybe lower than the various financial products or asset classes, but if do not follow those and make losses the effective negative returns can easily negate the effectiveness of that asset class. In simple words if you earn 9.5% on FDs and earn 11% from equity, yes, equity is good, but if you do not choose the right investment product or the right companies to invest in and get returns of 8% than certainly FD is better for you. Let us say you have an FD and equity investment, even then at times equity can give negative returns, so even -2% returns, than it eats in to the 9.5% earned on FD as well and your overall investment gain is 7.5% or maybe even lower if the markets are bad or you do not know when to switch funds. Hence is always better to focus on avoiding Bad Investments rather than focussing on Good Investments.