Investment Pitfalls

Concept of Diversification:

This concept requires that wealth should be invested in a large number of investment products including rental properties, government bonds, precious metals and commodities, national and international equity investment, etc. the purpose of diversification is to reduce risk associated with the individual investment. A very good company or sector is susceptible to various risk factor that can endanger its existence such as market competition, product become obsolete, technology changes, political and regulatory risk etc.

The problem with diversification for an small individual investors is that a lot of capital is required to achieve a small degree of diversification. for example during January 2016 a portfolio comprising 500 shares of 11 auto companies listed on Pakistan stock exchange would require 23 lac rupees. One possible solution is to invest in common pool of investment such as National Investment Trust.

Although mutual funds provide diversification benefit at low cost, it often devoid investors with trading opportunities. Recently for example, mutual fund holders were unable to divest their interest in oil sector as they do not have control over their portfolio. they are left with hob-sons choice either exit the fund or face the oil risk.

Equity Investment in falling stocks:

For a small investor, there are three source of income from equity investment. They include dividends in kind or cash, capital appreciation, and trading opportunity in the stock. A falling stock looses its value overtime. It is difficult for Market participants to sell their shares once they buy. There is strong inclination to invest more and more money as the stock falters. The investors get trapped once the stock reaches very low price zone. The trading in the stock declines significantly as well as the dividend yield and price appreciation. 

Consider the case of Azgard9 Ltd.

Azgard9 limited is a composite spinning, weaving, dyeing and stitching unit engaged in the manufacture and sale of yarn, denim and denim products and is listed on Pakistan Stock Exchange. The stock price of Azgard9 limited were 70 rupees at the beginning of April 2008 and the stock price tumbled by more than 95 %  by the end of year 2011. During this period, the company posted heavy losses and did not pay any dividend. 

For an individual long term investor, equity investment in this company would be a great mistake. Whoever has invested during april 2008 and December 2011, they got stuck up in the stock and lost their money.