Let’s look at five financial habits that individuals should discontinue if they aim to maintain sound financial health. If any of these habits resonate with you, it’s crucial to break free from them.
Investing in stocks directly without research
Purchase individual stocks only if you possess a solid understanding of the markets and have the time to thoroughly research and analyze stocks. Small investors should refrain from direct stock investment unless they can dedicate sufficient time to research. Retail investors are advised to steer clear of individual stocks. Opting for mutual funds provides a more prudent approach to profit from stocks. While investing in mutual funds does not eliminate risk entirely, it certainly mitigates it. Unfortunately, this straightforward guideline is overlooked by countless investors enticed by the thrill of independently buying and selling stocks.
Also read: Are you saving enough for your retirement, children’s education?
Buying too many stocks, funds to diversify
Diversification is a strategy that disperses risk across a range of securities, but excessive diversification may have counterproductive effects. According to the modern portfolio theory, maintaining a portfolio of 15-20 stocks from various sectors can effectively reduce portfolio risk. However, beyond this threshold, adding more stocks does not yield further risk reduction, as market risk cannot be eliminated. It emphasizes the importance of finding a balance in diversification to optimize risk management within a portfolio.
The scenario is comparable when investing in mutual funds. While diversifying across fund categories is advisable, acquiring an excessive number of funds within the same category does not contribute to portfolio diversification. Large-cap funds, for instance, exhibit minimal variation in their portfolios. The top 10 holdings of major large-cap funds often consist of similar stocks, with slight variations in individual stock exposure percentages. Therefore, purchasing too many funds within the same category essentially duplicates your holdings rather than enhancing diversification.
In an ideal scenario, maintaining a portfolio of 6-8 equity funds that focus on distinct segments can provide optimal diversification. A well-diversified equity fund portfolio typically allocates 40% of the corpus to 1-2 large-cap funds, followed by 30% in 1-2 multicap funds, and 20% in 1-2 mid-cap funds. The remaining 10% can be invested in a small-cap fund to enhance potential returns. This balanced distribution across different segments helps create a diversified and resilient portfolio.
Also read: What is the 50-30-20 rule in financial planning?
Not saving for emergencies
It is crucial to anticipate unforeseen expenses and other financial contingencies. The escalation of lifestyle expenses and the abundance of spending options can cause individuals, particularly the younger generation, to overlook essential life necessities. Facilitating this spending trend are credit cards and mobile wallets. Although these tools offer convenience, their irresponsible use can easily lead individuals into a debt trap. It’s essential to strike a balance between convenience and responsible financial management to avoid potential pitfalls.
Buying insurance to save tax
Annually, millions of buyers invest significant sums in insurance plans that may not be necessary. The allure often lies in the “triple benefits” of tax deductions upon investment, life coverage throughout the policy term, and tax-free income upon maturity. However, traditional insurance plans, while providing tax advantages, fall short in terms of offering adequate insurance coverage and generating substantial returns. Unit Linked Insurance Plans (Ulips) offer slightly better prospects but are beset with issues such as a lack of transparency, liquidity challenges, and limited flexibility. Careful consideration is essential to make informed decisions about insurance investments.
The primary objective of the plan, which is the insurance cover provided in the event of death, often tends to be the least considered aspect for the average insurance buyer.
For senior citizens, investing in market-linked instruments may not be advisable at this stage of life. A more prudent option would be the Senior Citizens’ Saving Scheme, which not only provides tax savings but also ensures a steady and regular income.
Traditional plans often use enticing terms like “guaranteed,” “assured,” and “money back.” However, it is important not to be lured solely by these terms. While these plans may seem promising at first glance, a closer examination often reveals that the actual returns they offer are no more than 5%. Investors must look beyond the marketing language and carefully assess the financial implications before committing to such plans.
Ignoring outstanding debt
It’s essential not to overlook credit card statements and SMS alerts from your bank. Credit card fraud has become a prevalent occurrence. With the RBI’s regulations requiring SMS alerts to customers, it is crucial not to disregard these messages, especially multiple transaction alerts. Reporting any unauthorized transactions within three working days is imperative to ensure zero liability in the event of fraud. Staying vigilant and promptly addressing any suspicious activities can help protect against potential financial losses.
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