Buy what you Understand and Understand what you Buy
In our daily life, we make so many simple transactions routinely which are very easy to understand, just think about it. We go to grocery store and buy grocery to consume, people who lives Frugal Life they mostly know why they bought what they bought. We go to office canteen to have some food. We go to fuel station to refill our vehicle fuel tank. Are these transactions not simple to make and simple to understand. I am sure they are.
But do we make such simple understandable transaction when financial things are involved?
Lets face it, most of us have made this mistake. Don’t worry me too included here. Some relative or friend of your parents came to your home and suggested (read forced) you to invest in some Endowment (mostly LIC) plan wherein you will have to invest only X thousands annually and you are told that you will get all your paid premiums back along with some interest on it (mostly less than 5–6%, you are lucky if you are getting 5 even) which will be more than your 3 or 4 times of your annual income as of now. And in case, just in case, if you die in between then your family will get some lacks of money (read less than 20 lacks mostly, I am sure). And here is final shot from him which convinced you, “You will get tax benefits under 80C”. And, I am sure you were sold that policy and holding it in your hand in few days. Did we understand this transaction, mostly NO. Was that an Investment OR Insurance. It was both if you do not want to accept it as a mistake at first place, which anyway you will figure out in few years. Otherwise, actually it’s neither of them. It’s neither an Investment because simple rule of investment is to grow the money and beat the Inflation on long term bases. And certainly it’s not an Insurance either, simple rule of Insurance is to cover your family expenses in your absence and back-fill your income, but 20 lacks are not enough for 20 years of dependent family with at least a child.
Compare to Endowment plan Term plan is very simple to understand and it serves only one purpose of your financial life that is Insurance, and it serves it better. You pay less than 10 thousands (max 15) of premium to get cover of 1 crore. If you dont die then you dont get anything back but at least you lived to enjoy and support your family. And in case, again just in case, you die your family will get 1 crore, which is more than enough to cover 20 years of life for your dependents.
It can not get simpler than this, if you know any then do let me know in Comments.
You met with a friend who made awesome returns in stock market. He blabbers some company names and in a weeks time that stock is in your demat account. I have been through this situation many time, and believe me it’s a very easy trap to fall in. If it’s not a friend then some news channel or a site where people get paid to encourage others to buy, but not sell. But scenario is same. You bought that company stock without understanding it’s business and I wont be surprised if it was a loss making transaction for you OR you are still holding it with 30+% unrealized loss assuming it will bounce back some day and you will sell it on X% profit. It’s not going to happen, at least in near future.
Wont it be better if we understand the business of company and it’s profit making parameters before we buy OR at least after buying it so that we know when to get out of it and book our profit (or losses).
Always do research about company before buying stock of any company.
To start with you have had not more than 5 mutual funds in your portfolio, but as you started understanding (reading) about other mutual funds, and no wonder, in a years time that count doubled. And now we are not sure which one is doing better.
It makes more sense to have every mutual fund tagged to life’s investment goal. And follow it through at least a full economy cycle to understand if it gives risk vs return exposure of your tolerance level. It does not make more sense to have multiple funds of same category for a single goal as most likely majority of their investments are in similar company. Should you find a better mutual fund then put it in your watch list and slowly move your investment to that fund and get out of earlier one.
These are just three broad scenarios. There could be many. If we start to understand what we are buying OR bought then believe me life will be much easy and wealthy.
So, Buy what you Understand and Understand what you Buy.
Originally published at The Simple Personal Finance.