SIX COMMON MISCONCEPTIONS OF INVESTORS

The world of investing can be cold and hard. Especially when you start overestimating your abilities. Unfortunately, many also hold on some misconceptions and tend to act under their beliefs and perceived abilities. In this article, we explore some of these misconceptions and beliefs which are harmful to the interests of the investors.

1.       BEING INTELLIGENT IS THE KEY TO SUCCESS

Intelligence is overrated. Studies have shown that being intelligent, by itself, has little correlation to success in life. You do not need to be from IIM or IIT to succeed as an investor. What matters more is, in the words of Warren Buffet, rationality and emotional stability. Interestingly he says that if you do have an IQ of 160 (considered very high), you should “give away 30 points to somebody else” because “you don’t need a lot of brains to be in this business”.

 

If one is not into researching stocks and directly investing, which is a full-time profession in itself, one really has no need for any intelligence. As an investor one needs only average intelligence to be able to understand and take personal finance decisions based on simple logic and reasoning and ignore emotions and personal biases from these decisions. As is often said, investing is simple but not easy. Intelligent people may often complicate things, including their portfolios and investment strategies. Intelligence often also comes as a hindrance in accepting that you made a mistake and accept contradictory views. Brilliant people may also get attached to their models and put a lot of thoughts into their actions. Temperament rather than intelligence is the key.

2.       INFORMATION AND NEWS IS VAUABLE AND ACTIONABLE

Do you really believe you have access to any undiscovered information that can impact markets? Do you think you can make use of this info and perhaps every important news as inputs to make investment decisions? If you do, how has it impacted your returns? The only ones who share information and peddle views, tips on them are those who either sell information or profit from the clueless small investors who trade on its basis, lured by the promise of high returns.

This belief also correlates with the earlier point. People with high intelligence often lack the temperament to control the urge to react to information and make changes to the portfolio every now and then. If only markets reacted logically, every economist and analyst would have been a millionaire. Over 95% of all what we read and hear is noise and bears no material impact on our returns, although it may have a negative impact if we intuitively act on them! The rest is what remains “may” warrant some consideration, factual or fundamental in nature or voice of the experienced investment gurus in market swings.

 MARKETS ARE FAIR AND CARE ABOUT TODAY

The efficient market hypothesis also known as the efficient market theory is a very common/popular theory on equity markets. It says that the share price always reflects all information and trades at fair value in the markets. This makes it almost impossible for investors to purchase undervalued stocks or sell stocks at inflation prices. This theory did help Eugene Fama an economics Nobel prize in 2013, unfortunately, though, it hasn’t really helped investors meaningfully.

Reality is far away from this rational theory which keeps running into irrational investors in the market. In reality, there are many different types of players in the market with different objectives – traders, speculators and investors. This makes it difficult for a small investor to estimate the real, fundamental value of any stock. The recent months we experienced once again that markets behave irrationally, at extremes. Wise investors need to look out for the irrationality of the markets to find opportunities and act in contradiction to the markets instead of believing blindly in what it tells them.

4.       NOT HAVING A PLAN IS NOT A BIG DEAL

There is a maxim used by traders in the market which very few investors may have heard of - “plan your trade and trade your plan”. While we are not in the business of trading, nothing stops us from learning from this maxim. What it simply says that before investing even a single rupee, we should have a clearly defined plan or strategy or an objective/purpose for investing at the very least.

Investors should have defined goals or portfolios that follow a strategy – the most ideal being the asset allocation strategy for retail investors. Having a strategy is what gives you an answer as to what to do in different market cycles. Effectively, you will be investing in your strategy and not the underlying products directly. It would also help you rebalance your portfolio periodically or during sharp market movements. Managing your portfolio manually is possible but one may not be able to consistently follow a strategy

  TOP PERFORMING FUNDS ARE THE GOOD BETS

Should I switch to top-performing funds? With rising awareness and easy access to investment applications, many investors feel that they can easily find top-performing funds and ask this question. Wouldn’t it be so easy for everyone if things were so simple? The real question investors should ask is ‘do top funds continue to outperform’?. The answer to this is that they often don’t.

Likely, a top-performing fund today may not be so two years later. Taking decisions purely based on historical returns is not a good idea. Most websites and mobile applications showcase ratings that are purely on these historical returns and do not consider many other crucial factors important for decision making. Some experts claim that only about half of the top-performing funds do better than average returns in the next year. It is a fact that chasing top performers can be harmful to your portfolio and this is what many new investors are now realising. The regulator, in fact, mandated the publication of the standard disclaimer - ‘past performance is no guarantee of future performance”.

6.       TIMING THE MARKET IS POSSIBLE

“Buy low sell high”. Sounds very exciting! Market timing makes for a great story and that is why so many investors are attracted to this idea. There is an underlying belief here in our ability to predict markets and actually even call out on market tops and bottoms. However, this strategy clearly falls apart under scrutiny. Markets can stay irrational for a longer time and can test the patience of a rational mind. The primary reason being, the markets are not efficient and not rational. We have seen so many market booms and busts, however, there is little evidence that anyone has successfully and consistently predicted them with definite time frames, including the top investment gurus in the world.

Research suggests that investors who buy and sell stocks during periods of market volatility may see lower returns than investors who stick with an established investment strategy. Studies in US markets have shown that investor would need to accurately time the market 74% of the time to earn more than someone who just stays in the index. Another study indicated that less than 50% of “market timing experts” predictions were correct. You can better toss a coin to get a better prediction. Trying to predict markets can leave your portfolio in a vulnerable state. A better strategy would be to simply follow a disciplined investment approach like SIPs and/or following an asset allocation strategy. Following this approach and sticking with it will leave you in a much better position to achieve your financial goals.

This article is an extract of our article published in September 2020 Digital newsletter

THE 7 GOLDEN RULES OF WEALTH CREATION

We all have dreams and aspirations, especially when we are young. Be it an early retirement or palatial home or big cars. Unfortunately, most of us find us difficult to reach these dreams and have to either give up on grand dreams and set realistic ones or wait till you become too old to afford it. There are only two ways to ensure that you change this. First, earn enough money which may or may not be possible for everyone. Second, walk the easier but the longer path of saving & investing.

One of the important pillars of financial wellbeing is proper financial planning. Financial wellbeing is simply where you have more than what you need, and the extra is invested for an even better future. Often, we complicate wealth creation much more than needed. At risk of repetition, we dare say again that we have to go back to the same age-old principles of investing and wealth creation. They are timeless, simple and yet, very easily forgotten. There are still people out there who have dreams and aspirations but do not follow these critical and life changing rules for wealth creation. In this article, we present the seven rules of wealth creation

 

1.       Time is of essence:

Starting early is half work done. The best time to start investing was when you got your first pay cheque. The next best time was not today, but yesterday! There is no tomorrow, you have got to do it today if you are serious. We all know about the power of time and the power of compounding which can do wonders. But unless you don't start early or asap, the end date for the wonder to unfold will be too late. We have to get time on our side else, we would have to work doubly hard to make up for the lost time.

2.       Saving aggressively matters:

Give a 5-year-old child her favourite ice-cream and ask here if she wants to eat it now or give it back and have two the next month. What will she do? Often, we are no less than that 5-year-old kid when it comes to choosing between instant vs delayed gratification. We cut corners here and there to buy things we don't need to show off before people whom we don't like. Frugality and minimalism and the in words today. Instead of spending on riches & luxury, it's always better to spend on upgrading yourself, learning, setting up side-business and save /invest in appreciating assets at the very least. The more focussed and aggressive you are today and the more you enjoy the journey, the sooner will you reach your destination.

3.       Asset Allocation, is the key:

We often cannot see the forest for the trees. We lose sight of the big picture and spend more of our time in knowing which fund will perform the best, which is the next big multi-bagger, how my funds have performed, and so on. How does it matter even if your fund level performance if plus or minus a few percentages when it occupies only a fraction of your portfolio? Shouldn't we really see the big picture? A typical household in India today has huge exposure to real estate and gold, occupying almost half of all the wealth. The other half is in financial assets where again bank deposits, government small saving plans, insurance investments, etc garner a large share. The lowest exposures are to equities and mutual funds - the products which are crucial to exponential wealth creation over the long term. What we are only suggesting is that everyone should have a well-balanced portfolio with the right exposure to equity asset class as per the risk profile & returns expectations. This will have to be revisited and portfolio rebalanced from time to time, periodically and market event driven.

4.       Emotions need to be tamed:

Many studies have found that equity markets have delivered very attractive returns over the long term, outperforming other asset classes. This is in spite of all wars, events, crisis, pandemics, etc, etc. However, investors have rarely made those kinds of returns. And the reason is exactly these temporary aberrations which tested the conviction of investors and most investors unfortunately failed. Warren Buffett once said "If you cannot control your emotions, you cannot control your money." Our emotions and our behavioural biases often cloud our decisions and instead of acting rationally and against the herd mentality, we become part of the herd. We enter markets when it is late and exit early. With all the noise around us and all the easy information available, we try to time markets and make 'smart' decisions, when perhaps, even getting stranding on a lonely island without a mobile network would have proved to be financially more profitable! Remember, even refusing to do anything is doing something.

5.       Diversification helps, but only to that extent:

We all know that diversification reduces the overall risk of your portfolio. The guiding principle is that not all assets will behave the same at the same time as they would carry different set of risks and return factors. Diversification at the broad level is required also so that you can play that asset allocation game properly and as per a set strategy which can be executed on an ongoing, periodic basis. However, too much diversification into too many asset classes, products, etc would also mean that a lot of underperforming assets sneak into your portfolio. You can't really make good money betting on all horses in a race. Some experts are also of the extreme view that you diversify if you don't really know what you are doing. So it is a matter of the optimum balance, the right mix of a few important things. One may zero it down to say equity, debt and physical asset classes and have exposure to select financial products /securities within these asset classes and again some limited diversification w.r.t. fund categories, AMC, market-cap, sectors, duration /time to maturity, underlying instruments, etc within these products.

6.       Don't miss out on wealth preservation /protection:

All it takes to wipe out your wealth, is one unfortunate moment, event in a lifetime. We have seen many cases around us where families have been pushed back on years of progress in life by a tragedy, by business losses, by court cases, by crimes, accidents and so on. We can't really control what can happen in life, although we can be careful. However, we can certainly control the financial repercussions originating from such events such that our financial well-being is not compromised and we are not left at the mercy of fate. Having proper insurance, is one sure shot way of minimising financial losses and suffering. There are many products out there, both personal and non-personal out there which can protect us financially. Explore products related to life, health, personal accident, critical illness, home, motor, fire, travel, shopkeepers', professional indemnity, etc to minimise your financial suffering. The other way to minimise financial risks in life is to not take unnecessary risks (avoidance) and huge bets.

7.       Build on yourself. Build multiple sources of income:

One thing very common in all self-made millionaires is that they take themselves seriously. They are clear on what they want, they are focussed and passionate, have build good habits, strong character and display behaviour in line with their image and goals in life. They invest in people, in learning, developing their knowledge and skills, in building networks. Often, they don't risk everything on one product alone, even though they may be committed to one idea. They would have multiple sources of income, diversifying to things which interest them. They would try and automate /outsource /partner with or hire people in such a way that these different sources of income take very little time of their own. For them, money is not the destination or end goal but its journey, the game that excites them. This is what sets up apart from all of us on the wealth creation journey. Picture yourself what you want to become and be that today.

The above is an extract from my digital newsletter of December 2022.