Scientist and statistician Simon Ramo wrote a book in 1970 ‘Extraordinary Tennis Ordinary Players’, trying to compare the game of tennis with investing. According to him, in expert tennis 80% of the points are won while in amateur tennis, 80% of the points are lost (called unforced errors). The result of the tennis game is determined by the activities of the loser. Similarly, most of us are amateurs in investing but never accept it and keep on making ‘unforced errors’.
Mistakes are an inevitable part of our investment journey and even the greatest investors cannot avoid them. The famous American investor Charlie Munger once said – It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. To achieve your financial goals, you do not have to be very smart – you just have to avoid big mistakes.
What are these big mistakes? Borrowing money to make high-risk investments, concentrating your portfolio in a few risky assets, evaluating long-term investments on a short-term horizon etc. are the most common big mistakes. Any one of these can cause large losses in your investment journey and permanently hurt your long-term returns.
Let us understand through an example – Two friends Rahul and Aditya invest in the stock market through a portfolio. Rahul is an aggressive investor who owns a concentrated portfolio of 4-5 stocks. He often generates great returns, but sometimes also makes large losses when his stock picks fail to deliver. His friend Aditya is conservative in his approach and puts his money in a well-diversified portfolio of larger, stable companies. Below are the returns both friends achieved over the last 10 years.
Rahul’s portfolio returns look more exciting with two bad years, but his total annualised return over this period is only ~5%, while Aditya earned ~8% over the period by avoiding big mistakes.
Markets are always uncertain and therefore the best long-term strategy for most of us is to focus more on generating consistent returns over the long term by avoiding risks that can cause big drops in our portfolio. One good way to achieve this is to invest systematically (SIP) in a well-diversified portfolio that is matched to your risk profile. Or get help from a financial advisor or an app providing financial guidance which can help you avoid making big mistakes and achieve good long-term results.
