Beginner investors may not be used to periods of market lows that seasoned investors are familiar with. During high-stress situations, it can be very tempting to make panic-driven decisions like selling your SIP mutual funds and switching from equity to debt to protect your assets. Unfortunately, moments of panic can be costly for your financial future. Here are some financial mistakes to avoid in panic situations.
Getting rid of Equities
During times of crisis, some of the most common mistakes a beginner investor could make are
- panic-selling equity mutual funds that appear to be underperforming
- availing of instant redemptions by selling off other investments.
You might see your equity funds underperforming and want to sell/shift these mutual funds to other ‘safer’ asset classes such as government bonds. The reason is simply that market lows can cause feelings of fear and this emotion may drive you to act on impulse and sell your holdings. The reality is that markets go through temporary phases of highs and lows.
A market is unlikely to stay in a period of underperformance for more than a few months at a time. If a market is currently underperforming for whatever reason, it will eventually start to do better once the economic conditions improve. If you choose to weather the current market conditions with the help of rupee cost averaging, you can actually obtain more equity holdings via a SIP for a lower cost. Once the market conditions improve, these holdings usually become a lot more profitable, as their value increases.
Additional Read: Why are SIPs an Ideal Choice for the First-time Investor?
Not paying off pending loans
Loans are quite deceptive as their hidden cost can turn out to be a major financial drain. During an economic crisis, you may want to pay in small instalments as you feel that is more convenient. In certain cases, this is actually much more expensive as each year you carry forward your loan, a relatively severe interest rate is applied. The longer you choose to avoid paying off your loan in full, the greater the rate of interest applied to it, and the costlier your loan becomes.
It may actually prove wiser during an economic crisis to pay off any pending loans while you have the funds to. This pending debt is no longer a financial stressor once you pay it off. Additionally, there is no risk of the interest on the loans taken growing significantly once the financial year ends. By not paying off pending loans, you are only adding to any financial obligations you have. Over time, this usually proves to be incredibly costly.
Going overboard with stocks
On the opposite end of the spectrum, there are investors who believe that times of crisis mean jumping into equities. While it is considered wise to hold on to equity investments during a crisis, it is important to buy any mutual fund investment in a careful and measured way; not haphazardly. Since overbuying is driven by fear, albeit of missing out, this is also a kind of impulse purchase like the one mentioned earlier.
For example, someone who takes a huge risk by investing all their savings into a small-cap equity mutual fund with the goal of making massive profits eventually is taking an unnecessarily huge risk. Not only is a small-cap equity mutual fund a high-risk fund, but it also poses a magnified risk during an economic crisis owing to market conditions. As mentioned before, the pendulum need not swing in the polar opposite direction as that can be costly in its own way. In short, overbuying and overselling equities are both financial pitfalls one may be tempted by during a time of market crisis. Both should be avoided.
Additional Read: Investing in different asset classes based on their risk
Not budgeting your expenses
This is a common assumption people have during a crisis, wherein they feel they have not saved for an economic downturn so there is no point starting now. The truth is that it is never too late to start saving. An emergency corpus is always useful to have. Set aside 30% of your monthly income and budget aggressively, as this will help in managing your finances during an economic crisis.
Deliberately setting aside funds will also help in a proper reflection of your current financial scenario. The careful analysis of one’s finances is especially important during an economic crisis. You will be forced to assess your income streams, cut out unnecessary expenses, and evaluate whether the amount you choose to spend on certain necessities and luxuries is apt.
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