Come out of herd mentality to be a successful investor

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October 30, 2015 12:05 AM

In investments made on account of peer pressure, the capital allocation is often not in line with your investment framework. This may lead to risk of capital erosion and stress

Too many financial products in the market have made the selection process difficult for retail investors. Is there a way out to create an asset for the long term or generate consistent cash flow in line with the investor’s requirement?

Investing is a process based on one’s short-, medium- and long-term needs. Each one of us has unique needs and what is good for your friend or colleague may not be good for you. One must avoid peer pressure in investing. There are many instances where one invests in a particular asset class purely on peer pressure and suffers in the long run.

Remember to look at the opportunity cost or the cost of investing in alternate assets. In investments made on account of peer pressure, the capital allocation is often not in line with your investment framework. This may lead to risk of capital erosion and stress.

As a basic framework, one must have a Investment Policy Statement (IPS). Keep a note of asset allocation and, within asset allocation, the capital allocation. Do keep in mind the need for rebalancing the portfolio during volatility of any kind. The main factor that must be kept in mind when formulating the IPS is to remove emotions from investing.

During volatility, reacting to price movements will harm your investment portfolio in the long-run. The sooner you remove emotions and incorporate process in the investment framework, the more stable will be your return in the long-term. Once the IPS framework is understood, you should look into asset allocation and capital allocation. While many may consider the two to be same, in reality, both are different.

Let’s understand this with an illustration. As per the IPS, the capital to be allocated to equity is 60% of investible surplus. Within equity you have options like direct equity, mutual funds, Portfolio Management Scheme (PMS), to name a few. Within equity mutual funds, there are further options like large cap, multi cap, mid cap and small cap.
It is important to allocate the capital according to your needs and goals. If volatility affects you, a large-cap mutual fund will be ideal for you. If you consider volatility to be your friend, you should look at mid-cap mutual funds, or even direct equity. There is no correct answer. But one thing is certain — what is good for your peers or colleagues, need not be good for you. So you need to come out of the ‘herd’ mentality. Collective failure is acceptable, but in singular success, you may have difficulty.

Believe in the process and give time to the investments made to reap steady long-term returns. Investments based on price movements or daily trading should be avoided. But if you still can’t avoid the thrill of stock trading based on price movement of the scrips, allocate not more than 5% of your total corpus for this and do monitor the portfolio regularly.

Do ensure that strict stop-loss and targets are set initially and adhered to during volatile phases. Each one of us have unique needs and having an investment framework before putting in money is important. Any headline with words ‘hot’, ‘now’, ‘double’ warrants a second look.

When you undertake any investment like buying a house, shares or bonds, try to understand the nature of the product — whether the returns are market-related or market-agnostic; whether it’s fixed income, equity or hybrid; whether the investment strategy is short-term or long-term; and whether the investment generates income and helps in wealth creation.  Also, find whether your capital is protected; if not, it merits a revisit.

The writer is founder & managing partner, BellWether Advisors LLP

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