“Unforced Errors”: Investors must avoid.

unforced eroorIn tennis, the word “unforced error” is described as a missed shot that is entirely a result of the player’s own blunder and has nothing to do with opposition’s skill. Mostly the player with lesser committed unforced errors wins the game. In investing also, if we can minimize unforced errors, the chances of getting multibagger return shoots up.

World of small cap investment is full of risks & rewards, but at times investors tend to go overboard & increase their risk unnecessarily. Blindly taking more risk does not increase return, in fact it’s detrimental to your wealth. In this article, we will figure out the most common mistakes which many small cap investors commit. We believe if a small cap investor can manage “unforced errors”, there is no stopping of his wealth multiplication.

If I ask what is your investment horizon, most people will say its long-term. The problem is that long term differs from person to person, for someone it is 1 year and for someone else it is 10 years. If you are in equities, we believe your target for long term should be minimum 3 years & beyond. Since small cap investor has a higher risk appetite, it often leads to the belief that higher risk appetite is equal to adventure investing.

In adventure investing, investor keeps on buying & selling stocks within 3 to 6 months with small returns. Sometime in few days a well. Also these days, print media & business channels are feeding multibagger stories by churning past data. While such stories are good for media business, it is not good for your portfolio. Higher risk appetite forces small cap investors to believe that they can buy one more stock in their quest for finding next multibagger. As time passes, it results in having a portfolio of 50 to 100 or even 200 stocks. Even if some stocks perform well, overall returns remain average due to poor performance of other stocks.

The problem does not end here, most stock advisory firms, who promise you next multibagger stock, will also keep on selling stocks in the name of profit booking. This is in direct contradiction to multibagger returns since one has to keep stocks for many years so that initial investment can multiply. Merely booking 100% profit is not going to help because real multiplication starts after 100%. If you book 100% profit & buy another stock in the hope of another 100% profit, you are actually increasing your risk of finding two multibaggers in two calls i.e. a 100% success ratio, which is a sure recipe for failure. On the other hand, if you remain invested in same stock & it goes further 50% up, you would automatically get 100% more returns by doing nothing.

If you research on most successful investors, they have held stocks for 10 to 20 years, someone like Warren Buffet has been holding Cola-Cola since almost 30 years now without selling a single share. We are not saying that you should hold every stock for 30 years but all that we are trying to imply is that you must hold a stock longer than a just few months if you are looking for big returns. Only three things should force you to sell a profitable stock, we are listing all three of them under the assumption that you only invest your surplus money into equities:

  • Either stock fundamentals have changed & your investment theory is no longer valid.
  • You are close to your goal fulfillment for which this investment was initially made, for example if you had invested for son’s education then you should sell and book profit couple of years in advance.
  • Nothing else matters other than above two rules.

Following these rules are easier said than done. You need to have a mature investment process in place. Prefer goal based investment as in absence of it there is a very high probability that you will not be able to follow these simple looking rules under constant influx of news from internet/print media/business channels.