Herd mentality can hurt you

Since your financial needs are different, it is important to have a strategy that is tailor-made to meet them

Steven Fernandes / Jan 20, 2013, 00:44 IST

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Lata Desai, a school teacher in Pune, has recently started a monthly recurring deposit scheme with her jeweller. Her inspiration: A neighbour, who told her that a lot of people were doing this, because gold prices have gone through the roof. Desai hopes to buy jewellery by saving small amounts of money this way. The thought that this jewellery, accumulated over the years can become a good investment was also an attractive proposition for Desai.

Similarly, Rajeev Gupta, a vice – president with an FMCG firm recently sold all the equity investments he had been holding for the last two years, as they had not performed as per his expectations. He invested the money in a real estate project along with his friends who convinced him that real estate was the best investment currently. They based their decision by the returns generated by real estate in the last couple of years.

It is not uncommon to find such instances. Often we are influenced by the latest trends and, thereby, end up investing in assets which might be in vogue at that point of time. We believe that since a lot of people are doing the same thing, we won’t be wrong.

TO CHOOSE THE RIGHT PRODUCT

Select investment products based on your goals   Do thorough research about the past performance of the product   Remember that higher returns come with higher risks   Don't fall for sales pitch by distributors

This behaviour can be attributed to the lack of financial literacy. It is seen even among investors in countries which have highly sophisticated financial markets, like the USA, for instance. This is the same reason why even Ponzi schemes succeed, as people get comfort in the fact that they are in the company of several like minded people who have invested and, therefore, the element of risk is also perceived to be lower.

Take the case of equity markets. When equity markets were going through a bad patch and most days the indexes are falling, the tendency of most retail investors was to sell and get out. Their fear was that it may fall further, thereby increasing losses.

Similarly, when equity markets start rising, investors who had bought gold and real estate, failed to see the signs of the revival in the equity market and continued to ignore it. But now that the index has moved up to dangerously high levels, it is attracting the attention of investors once again. Now investors are talking about putting money in equities once again and hoping that they don't miss the bus.

Once again, the topic of discussion in offices, during tea breaks, or at social gatherings is centred about how much the stockmarket has gained and how everybody is investing in equity. It is the same pattern being repeated all over again.

What are the consequences? 
Even though you have a very good intention of saving and investing, following the trend in investing without doing the due diligence can make you invest in the wrong assets or products, which eventually can lead to losses or inadequate returns. Some of the schemes may not even provide liquidity and if you have committed a bigger amount, you may end up getting into debt in case you are not able to liquidate those investments during a major emergency. How do you avoid such situations:
* Writing down your financial goals along with their time frame and value, can help you make the right start in your financial life. Based on the goals and time horizon, appropriate assets can be selected. For example, if you are planning for your child’s post graduation and if it is nearly 10 years away, then one needs to invest a major amount in equity. Similarly if funds are required for your daughter’s marriage after two years, then you should select safer assets such as fixed deposits or debt funds where there is surety of capital as well as fixed returns.

* Getting information on the product or asset and its past performance is necessary as it can give an insight into how that asset performed over different periods. With so much information available online nowadays, it is not difficult to find such information. If you don’t have the time then get it evaluated by a reliable advisor.

* If the returns expected are more than those offered by fixed deposits, then there is an element of risk involved. Ask yourself if you are in a position to take that risk in the pursuit of higher returns.

* Don’t make haste as the world is not going to end tomorrow. Sometimes the product seller or distributor may convince us to invest in a particular product by saying that the period for investing is going to end soon, or the price of the asset will rise as there is high demand. Most of us fall in this trap and we then don’t spend time to evaluate or verify whatever has been told to us else we might miss the opportunity. A little time spent on evaluating the advantages and disadvantages of the product can save you from future hassles.