This reminds us of a quip from Charlie Munger (Warren Buffet’s right-hand man) that really sums up ideal behavior when it comes to managing your money.
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
Ask us and we’ll tell you this – if you concentrate on avoiding bad decisions instead of focusing on making good decisions, you will become a better manager of your personal finances 🙂
Having said that, here are a few mistakes that most people make while managing money. We may or may not have committed a few of them in our past :). But like they say, knowledge is power.
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Looking at past performance to decide the future course of action:
This by far is the biggest mistake most investors (even the experienced ones) make while deciding on their future course of investments. Judging by past performance, a lot of investors end up dumping their investments that have done poorly in the past (which may have a possibility to recover in the future) and tend to hold on to investments that have done really well in the near past (these investments might be overvalued and may underperform in the future). The bigger point we are trying to make is that just relying on past performance to make investing decisions can result in loss of potential multi-baggers and/or holding onto/buying overvalued investments. Investment decisions have to be forward-looking and should involve a variety of metrics. You can read more about this here.
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Thinking of all Dividends as “tax-free”:
While you might be tempted to choose the dividend mode on mutual funds, thinking that you are receiving tax free income, do note that the mutual fund houses have to pay something called a “dividend distribution tax” which ranges from 10% (effectively around 12%) on equity schemes to around 29% on debt schemes. While you don’t have to pay this tax, the mutual fund house will deduct this from your returns only.
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Taking a loan at a higher rate of interest while keeping in money in a Fixed Deposit at lower rates:
This is a surprisingly common mistake many people make. It makes absolutely no sense to borrow money on EMI’s at say 12% while keeping money in a fixed deposit at 6%. The thumb rule is that – only take a loan when the existing money you have is earning a higher return than the cost of the loan. Cost of funds < Returns on Funds.
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Investing in too many different mutual fund schemes:
People over the years tend to accumulate a large number of funds in which they are investing. It is not uncommon to hear people holding 15–20 mutual funds in their portfolio. Not good. It becomes hard to track them and you will never outperform. As a thumb rule, it’s best to hold 2–3 Debt Funds and not more than 3–5 equity funds at any given time.
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Looking at the value of long-term investments too often:
We often come across people who initiate an investment which is supposedly for 10–15 years. But as is human psychology, if the value of the investment falls down in a few months they start worrying. It is important to let long-term investments create value over time and not be too bothered by short-term movements.
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Buying Insurance as an investment (ULIP’s, Endowment Plans) or buying term insurance when you have no dependents:
Insurance is often confused as an investment instrument. Never mix insurance and investment. Buying pure term insurance and a mutual fund will almost always give you better returns and protection as compared to endowments or ULIP’s. Also, never buy term insurance if you don’t have any dependents.
Everyone who invests has made these mistakes at some point. The best approach is to learn from them and ensure constant improvement in your money management skills. It is the one life skill everyone needs to cultivate!
Hope we were able to add some value to your investing experiences with the above-mentioned observations. We believe that personal finance should be adopted as a part of school/college curriculums in order to nurture an informed and aware investment community. Do visit our online investment platform, Moneyjar where we pick mutual funds for you to invest in using a similar thought process.
Happy Investing!