Why you lose money when you invest

“I lost money in mutual funds. I do not wish to invest in them again. I am happy with what my fixed deposits give me.” This was what a neighbour in my colony told me, as soon as he heard that I research mutual funds.

Naturally, when we burn our fingers, our first reaction is to shut the doors on that option. In investments too, we seldom look back to know why we lost money. Were we wrong, or were the markets? If you had invested in a ponzi scheme, evidently the product was wrong (although investors are almost equally at fault most of the time).

But in equity markets, or specifically, in a product like mutual funds, if the market/product was wrong, then why does it continue to have people investing and making money? Why is it that internationally, they are known to be proven vehicles to build long-term wealth?

Let me be candid: most of the times when a loss is incurred, the fault lies with investors and no one else. Here are a few obvious reasons I could think of on why we lose money when we could have avoided it.

Not having a time frame to invest

Not having a time frame compounds your errors. One, it makes you set wrong return expectations (like expecting double digit returns in a short period); two, it pushes you to choose unsuitable products (choosing an equity fund for a 1-year time frame); and three, it prompts you to exit at wrong times (panicking and exiting when markets are down soon after you invest).

Having a goal naturally puts a time frame for your investments. Moreover, it helps you choose the right product that is in line with your time frame and return expectations. Hence, if you have a goal, more power lies with you!

But if you do not have one and simply wish to save, then your minimum time frame has to be in line with the minimum ideal time frame of the product you choose. For example, at least a 5-year time horizon for an equity fund, and not less than 3 years for an income fund are basic rules that you need to follow. There is no point in blaming the product when you did not follow the investing rules for it.

Not knowing that trading and investing are different

Many investors start by saying they will stay ‘invested’ for the long term; however, they buy a fund/share hoping it will zoom right away. When it does not happen, they sell it. A few others who invest directly in the equity market and come to mutual funds look for ‘low points’ of the Net Asset Value (NAV) to invest in. They watch the fund steadily for its 52-week highs and lows.

Then there are others who stop their Systematic Investment Plans (SIPs) when the market moves up a bit one month, thinking that they should not be averaging at higher costs.

These are certainly not investing strategies that will fetch you money. They only delay the process of building wealth and often times harm your portfolio. Besides, products such as mutual funds are simply not built for ‘trading.’

If you are an investor, the only reason you should exit is when you near your goal, or when your fund/stock is really an underperformer vis-a-vis the market.

As for stopping your SIPs, there can be no single reason to compel you to do it. A single month’s 2-3 per cent increase in NAV cannot do your averaging any harm. Moreover, it will hardly matter when you see it from a longer time frame. All you would end up doing by stopping your SIPs on and off is that you would save and invest less.

Not having a perspective on returns/return expectations

“I got only 15 per cent on my mutual fund. I expected at least 25 per cent returns. I don’t want to invest more.” This is not an uncommon statement. So, what are your other options for getting that 25 per cent return?

Unregulated lending/chit fund schemes? Let’s look at returns relatively. You are happy with your Public Provident Fund (PPF) returns, and with your Fixed Deposit (FD) returns, but you’re unhappy with your equity returns. Why?

That’s because there is no guarantee. But it is precisely for the risk that you take that you are rewarded far higher returns than the other options. Hence, you will do well to see how much you get over your other options, or simply over inflation, rather than setting a number that perhaps has no basis.

When you do this, you will not only realise whether you get ‘good’ returns, but you’ll also know how much you need to fine tune/improve your savings, than expect the market to generate a miracle.

As for this gentleman who told me that he does not like mutual funds, he also disclosed to me a market-linked insurance plan in which he lost money. And he thought it was a mutual fund.

Now, can you think of a stronger reason for losing money than not knowing the product you are investing in?