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The Biggest Investment Mistake You Need To Avoid

Jul. 03, 2013 8:22 AM ET
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There are so many investment mistakes. But which is THE BIGGEST investment mistake one need to avoid? Lack of diversification, looking for instant results, not having a plan, not assessing risk level, timing the market, following the crowd…… Though there are many common mistakes investors around the world make, there is one mistake which is the father of all other mistakes.

As far as investment is considered there are some investment principles and there are some investment techniques. What is the difference

between principles and techniques?

Principles are very basic and will never change. Principles are guidelines. Principles are simple at the same time very authentic. The more closely investment plans are aligned with investment principles, the more accurate and functional they will be.

Principles are not techniques. A technique that works in one circumstance will not necessarily work in another. While investment techniques are situational specific, investment principles are deep, fundamental truths that have universal application. When these principles are internalized into habits, they empower investors to create a wide variety of investment techniques to deal with different situations. Techniques will enhance the results of the principle.

But always remember a technique or tool need to be in line with the basic principles. If we use a technique which overlooks a basic principle, then definitely we will have a very bad hit. So THE BIGGEST investment mistake would be falling prey for cheap investment techniques which are not in alignment with the basic investment principles.

Communication is a powerful technique. Accounting is a good tool. But if we use these techniques and tools as a short cut and not in line with the basic principles, what will happen? We know what happened to Nithyananda and Satyam Computers. You may seem to succeed, but eventually it is not possible to sustain that success forever.

Similarly investors need to be very careful about cheap investment techniques which are not in line with the investment principles.. They seem to be attractive, flashy, trendy, sexy but not authentic. They all look like the "get rich quick" scheme promising "wealth without work." These kinds of investment techniques are all illusory and deceptive.

Take for example the Risk-Return Tradeoff Principle. This is a very basic and profound investment principle. Low level of risk is associated with low potential returns, whereas high level of risk is associated with high potential returns. So as to generate high returns one need to tolerate high risks. If you are comfortable only with low risks, you can expect only low returns.

No one can defy this basic principle. A scheme cannot deliver high returns with low risk. There were no such schemes in the past. There are no such schemes in the present. There will not be such schemes in the future too.

Finance company deposits which assured high interest rates have defaulted. One of the latest examples would be the
ponzi scheme by Madoff.

Whenever you hear about such schemes with low risks and high returns, you understand it is an illusion. It is better to ask more questions and get it clarified, instead of making assumptions.

So the biggest investment mistake is to mindlessly following a technique which is against an investment principle. To avoid this biggest investment mistake whenever we come across a scheme or technique, consciously check up whether this scheme or technique is violating any basic investment principle or not.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Plannerof Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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