Copycat investing: Some investors make the mistake of making direct stock picks just based on the portfolio disclosures of their mutual funds, to mimic the fund manager. While it is not inherently wrong to consider these sources, it is important to be aware of potential pitfalls owing to the fact that fact sheets and portfolio disclosures provide a snapshot of holdings at a specific time, and due to this, investors might not know the full context or the investment rationale behind those choices.

These documents don’t include a thorough research, analysis, or market insights that went into the investment decisions. By the time an investor sees these disclosures, market conditions may have changed, and the portfolio may have already been adjusted.

Moreover, these stock picks might not align with the investor’s own risk tolerance, financial goals, or investment time horizon. Relying solely on a few stocks or mimicking a fund’s holdings might result in a lack of diversification, increasing the overall risk. Investors can use fact sheets and portfolio disclosures as a starting point for research, but should also do their own due diligence.

Concentration and over-diversification: Putting all your eggs in one basket is what causes concentration risk. When all your investments are too heavily focused on a single asset class or a few asset classes, it means you have a concentrated investment portfolio. For example, if most of your investments are just restricted to large cap mutual funds, that means you are possibly exposed to the same set of stocks across your mutual fund holdings. If even some of these companies perform poorly, your entire portfolio could suffer as a result.

On the other end of this spectrum, over-diversification is also an investment mistake. Over-diversification is when you spread your investments too thin. For example, several investors end up investing in 4-5 schemes in the same category. At any given point in time, some funds would do well and some would not. But due to an over-diversified portfolio, the investor’s allocation to the outperforming fund would be minimal. Also, studies show that beyond a certain number, the benefits of diversification peter out significantly, but an over-diversified portfolio will reduce the return potential of your portfolio. The ideal approach should be to smartly diversify by looking for funds with different investment styles.

Frequent and unnecessary portfolio churning: Churning refers to the frequent buying and selling of investments within a short period. Each time you sell an investment for a profit, you trigger a capital gains tax liability. Short-term capital gains (for assets held less than a year) are usually taxed at a higher rate than long-term gains. For direct stock investors, frequent trading can lead to higher costs with each trade, as you incur transaction costs such as brokerage fees. These costs can eat into your overall returns, particularly if you’re making frequent trades. This may also prevent your portfolio from benefiting from the power of compounding over time.

To mitigate these issues, consider a more strategic approach to investing, focusing on your long-term goals. Minimize unnecessary trades, opt for a buy-and-hold strategy, and consult a financial planner to create a diversified portfolio aligned with your objectives, while also managing tax implications.

Trying to time the market: Trying to predict market movements and timing entry/exit points can be challenging and often futile. Rather than doing their independent research, investors often get swayed by overall market sentiments, and end up buying at market peaks and selling at market bottoms. To be fair, it is not possible for anyone to identify peak and bottom of the markets with accuracy on a consistent basis. So, investors should remember that it is not so much about timing the market, but about the time invested in the market. Research shows that those who stay invested over the long run in a well-diversified portfolio generally do better than those who try to profit from the market’s difficult-to-predict turning points.

Emotional decision-making: Letting emotions like fear or greed drive investment decisions often result in impulsive choices. This takes us back to the importance of a disciplined approach to investing and sticking to one’s financial plan. Through bust and boom, it is important that investors stay focused on their goal-based investments and not unnecessarily tinker with them. Investors should learn to block the external noise, avoid chasing short-term trends or be driven by greed for superlative returns.

Nisreen Mamaji is founder of MoneyWorks Financial Services.

Updated: 24 Aug 2023, 09:37 PM IST