Unfortunately, investments and movement of asset prices don’t follow such laws. Asset prices don’t follow Newton’s law of motion, nor are they based on the Archimedes’ Principle. Asset prices move on the laws of narratives. And it’s nearly impossible to predict the direction of these narratives.
The most important principle of investment is that one should not fool themselves. Unfortunately, we fool ourselves daily and that’s why we are in perpetual stress to achieve our financial goals. So instead of focusing on short term narratives, the focus should be on long term trends of an asset class.
As markets are touching new highs, everyone is looking for the next hot stock. Hot stocks can make you rich, but they probably won’t. Over the long run, while the total stock market would do well, most individual stocks may not. Not every company can be an Apple, Google, Amazon, Facebook or Tesla. Similarly, in India, not every company can be TCS, Bajaj Finance, Asian Paints or HDFC Bank. Thus, having a well-diversified portfolio using mutual funds and buying plain simple broad-based index funds is the best way to reduce risk.
Today many investors are also getting lucky by making high returns by investing in IPOs, buying stocks on tips and investing in stocks with half-baked knowledge and information. Warren Buffet explains it well when he says, “It’s only when the tide goes out that you learn who has been swimming naked”.
In a bull market everyone starts believing that they have skills like Warren Buffet and can easily outsmart the market. Investment and valuation is a science which require one to deep dive into company’s balance sheet, management, cash flows statements and based on this do valuation to arrive at a fair price. Either one should do sufficient research before investing or outsource their investments to mutual funds.
Inherently, we don’t like facts and data but we love stories. Listening and sharing stories is part of our DNA. Our brain is a story-making machine and with our imagination we can explain everything. Future is uncertain and uncertainty brings its own set of anxiety. Stories help in making sense of the random world and helps in reducing our anxiety. No wonder, fortune telling is a big industry.
The only story which is true about the stock market is that it always fluctuates and at the same time it has the potential to create wealth i.e. beat inflation over a long period. Fixed income helps in capital preservation by giving returns in line with inflation. Gold is a good hedge for inflation and uncertainty.
Money is an emotional subject. It brings us anxiety, stress, insecurity, confidence, happiness and host of other emotions. We behave normally in normal circumstances and only show our true colour during times of extreme stress. It’s important to keep the extreme scenarios in mind while building the portfolio. We all are programmed genetically differently from birth, having unique behaviour. Our insecurities are also unique, based on our upbringing and circumstances in life. Everyone has different aspirations and have a unique view to look at money. One should have an asset allocation which is also unique and which matches to their internal score card.
Behavioural science says it’s very difficult to think beyond ten years. The most difficult question to answer in an interview is to answer: “Where do you see yourself five years down the line?”. Retirement seems a far distant goal and is the last item of financial planning. Working life is short and mortality is only rising in India. Most of us will have a minimum retirement of 20 years. A good financial plan starts with retirement planning.
Archimedes brought this concept of leverage around 2,000 years ago. He stated, “Give me a lever long enough and I would lift the earth”. Leverage is achieving significantly greater than the force one puts in. The lever here is to create immense wealth in time. Money compounds exponentially with time. The reason why a lot of smart people make big money mistakes is because they think that the lever is IQ and ignore time.
It’s good to save for goals like buying a car, house, children’s education, marriage and retirement. But saving should be an inbuilt habit even without any goal. One never knows when a family requires money. Most of us find it hard to save and invest. We all get influenced by the behaviour of people around us. In the company of people who play the lifestyle game will make us spend more. Choosing a right circle of influence is a smart hack to be a good saver & investor.
Friction is a force that must be overcome to achieve an outcome. The best way to save and invest is to automate. SIP is the best automatic which reduces the friction between the intention and final action to save and invest. Similarly, you can use automation of STP (systematic transfer plan) to invest from debt to equity if you are unsure of the markets and want to invest in a gradual way. SWP (systematic withdrawal plan) is a very effective way to withdraw money if you are planning for your retirement. Automate your bills and well as your investments.
Catalysts are the unsung heroes of a chemical reaction. They increase the speed of chemical reaction and the best part is that they don’t get consumed in the chemical reaction. A catalyst can be removed and used again. Having an emergency fund in the portfolio acts as a catalyst. Having sufficient safety net in the portfolio gives sufficient confidence to take risk in career, business and while investing in equity.
Nothing in investment has to be feared, it is only to be understood. In 2008, markets corrected by more than 50% and from the peak of 2008 to 2014, markets gave practically no returns. Have a lazy strategy, think decades, not years. Investment approach in 2021 – Hope for the best, have equities but also be prepared for the worst and have fixed income, gold and an emergency fund in your portfolio.
(Amit Grover is AVP for Learning & Development at DSP Investment Managers. Views are his own)
