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Why average investors don’t stick to basics of investing

After years of reading, studying and exploring personal finance and investing, one arrives at few basics of investing. These basics are simple, easy to understand and can be written on a single piece of paper. Therefore after learning about them, it is quite natural for a person to think that he knows enough of investing and can now do well as an investor.

Unfortunately, knowing basics and sticking to them are two different things. It takes lot of maturity on part of investor to abide by the basics of investing. This maturity comes from clearer and deeper understanding of investing. Average investors with superficial knowledge cannot hope to have it.

Listed down are some of the things that separate mature investors from average investors.

  1. Mature investors are free from false notions of investing. Here are few examples of false notions average investors hold as true.
    • It is possible to beat fund manager/Index returns by casually investing in stocks or by subscribing to stock recommendation services.
    • Midcap and smallcap give higher return compared to large cap. Therefore majority of equity allocation should be in mid and small cap.
    • It is possible to predict and time the market.
    • Equity beats fixed income for all time frames more than 5 or 10 years. Therefore all long term money should be in equity.
    • It is possible to find out the best performing fund by looking at past performances of funds.
    • Fund that performed better in the recent past is better fund.
    • Higher return generating funds in debt category are better funds. etc.
  2. Mature investors can spot bullshit that is peddled as expert opinion over social media, blogs, newspapers and in business news channels. It takes deeper understanding of investing to be able to do that.
  3. Mature investors understand how financial industry works. They can see things plain and take them for what they really are.
    Average investors on the other hand have no defense against marketing/selling tricks and influence tactics used by financial industry. They keep falling prey to every new fad and fancy in the market.  
  4. Mature investors understand psychology of investing. They are aware of mental biases that interfere in investing and know how to deal with them.
    Average investors are totally vulnerable to their own inherent mental biases and repeatedly commit behavioural mistakes of investing.
  5. Mature investors are aware about the history of financial markets and therefore understand risk better.
    Average investors have inadequate and mostly faulty knowledge of market history and therefore do not understand risk.
  6. Mature investors have no illusions of superior understanding of markets. They are intellectually humble because they know that they are dealing with something they can never hope to understand completely. Therefore they focus on avoiding mistakes instead of trying to be very smart.
    Average investors on the other hand think that they know and understand investing enough (“The less you know, more you think you know”). They are more prone to do something stupid while trying to do something smart.
  7. Mature investors understand the role luck plays in investing. They are usually sceptical of short term performances and tall claims made in the market.
    Average investors think that all investing success stems from skill. They often confuse luck with skill.
  8. Mature investors are better trained in inference. They know how to look at the data. They understand when and when not to draw inferences from the available data.
    Average investors have no such training. They draw links where none exist.

Clarity, deeper understanding and most importantly higher awareness of own ignorance is what help mature investors stick to the basics. Average investors lack all of this and therefore easily stray away from the basics. They keeps playing with their portfolios and end up committing mistakes that can easily be avoided by sticking to the basics.

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