7 Tricks You Should Avoid While Investing to Prevent Massive Losses

Featured Image Caption: Investment to Prevent Massive Loss

Equity investing, by default, is a risky proposition. You face the uncertainty of systemic and non-systemic factors. There are factors that are within your control and there are factors that are beyond your control. Here are 7 ways to ensure that you do not end up in huge losses when the market works against you. If you have been in the market for some time, you would know pretty well that volatility and disruption are part and parcel of the equity markets.

Let us look at 7 tricks in investing to prevent big losses.

1. Never buy into weakness or try to average

This is a common problem we may face in managing the portfolio. We buy into weakness for a variety of reasons. For example, we may estimate that a quality stock has corrected substantially and hence the downside risks are limited. Many investors did that with pharma stocks in the last 3 years and are still holding on to a loss-making portfolio. There may be nothing wrong with buying pharma but you need to appreciate that the undertone of the sector’s profitability is changing. A bigger error is averaging your positions. For example, if you had tried to average pharma in the last 3 years, you would still be averaging. When you see structural change, just stay off that sector.

2. Never sell into strength in the equity markets

This is a slightly tangential point to the first idea. Where do you see strength today in the Indian markets? For example, you can see strength in the private banks and the FMCG space. Obviously, many people are worried that such high valuations may not be justified. But don’t ignore the underlying strength in these sectors. This was the case even one year back. Imagine if you had bought into PSU Banks and sold out of Private Banks. It would have been a double whammy for you. It is bad enough to not buy into strength but worse to sell into strength.

3. It is absurd to be wary of tax harvesting

This is an interesting method of handling portfolio losses. If your portfolio is down by 25%, as is quite normal today in mid-cap stocks, you can book the short-term losses. Don’t get intimidated by the idea of booking losses, we are only asking you to harvest your taxes. Once these losses are booked they can either be set-off against other short-term capital gains or they can be carried forward for a period of 8 assessment years. Writing off such losses or carrying forward such losses can give you a tax shield to the extent of your peak tax rate. Normally, investors tend to wait for a bounce. Instead, harvest the losses and avoid your allergy towards harvesting tax losses…

4. Avoid becoming too defensive when markets correct

This is a normal tendency. You tend to become too defensive and stay out of the market. Or you put all your money in defensive high dividend stocks that will not go anywhere. Try to be a little more proactive. Every phase has some rank out performers. Forget about the big stories like IT, infrastructure and pharma in the last 20 years. Look at the last 5 years. You have oil marketing companies that became Multi-baggers. You have well managed NBFCs that gave great returns and of course, there are large FMCG companies that are doing very well. The Nifty levels matter only up to a point. When you get too defensive you lose out on these opportunities.

5. Give up your aversion to futures and options

A lot of investors have taken Warren Buffett’s words very seriously that, “Derivatives are weapons of mass destruction”. They are nothing like that if you know to manage your risk better. For example, to prevent big losses, you can lock your profits via short futures. Alternatively, you can hedge your downside risks using lower strike put options. Above all, you can also write higher call options to reduce your cost of holding stocks. When you get allergic to derivatives, you lose out on all these opportunities.

6. Do your homework before investing and do it thoroughly

One of the principal reasons investors make big losses is not doing their homework adequately. You need to spend time understanding the financial and non-financial strengths and weaknesses of the company you are investing in. There is a business behind each stock and it is this business that you are interested in. Your best insurance against a sharp correction in stocks is thorough research. For example, many have accounts for different purposes but after good reading about the options available, one can open a demat account, which is a singular account on a digital platform.

7. Taking a stock specific approach rather than a portfolio approach

What do we understand by a portfolio approach? Every stock that you purchase or every mutual fund that you invest in has a context. That context is your long term goal. When you peg your investments to your long term goals there are two distinct advantages for you. Firstly, your risk is automatically managed as you keep restructuring your portfolio as per our goals. Secondly, and perhaps more importantly, your asset allocation takes care of massive corrections. When your asset allocation compels you to keep shifting from one asset class to another, you are automatically booked out at higher levels and liquid at lower levels.