Investing? Set aside your emotions and it’s elementary

Published: November 4, 2014 4:49:40 PM

Investing is both an art and a science. Science, because it’s a process and...

Investing is both an art and a science. Science, because it’s a process and, art, because the personal preference of investment products determines how wealth creation takes shape. Both go hand-in-hand. And, if looked at more closely, investing wisely is elementary.
You decide the goal, time horizon, risk profile, liquidity and anticipated returns. Then, you look at investment products of different types and carry due diligence before investing.

So, why is that there is extreme euphoria and also extreme pessimism when returns in an asset class gyrate because of the economic environment and the actions undertaken. We live in an inter-linked and inter-connected world and the movement of investment happens in a jiffy.

Many a time, equity as an asset class displays extreme euphoria and extreme pessimism. Often, investors prefer secular income with minimum volatility. Which is why they have a substantial allocation of funds to fixed-income products, irrespective of liquidity needs and time horizon.

With equity markets in India at all-time highs, you hear specific stocks delivering multi-fold returns over multiple investing periods. Also, more specifically, top-quartile equity diversified mutual funds have delivered compounded return (CAGR) in the range of 15-20%. So, a 20% CAGR return over 20 years on an investment of R1 lakh is around R38.50 lakh now. It means a 38.5 times return.

But the question is, how many investors had the patience to stay invested over 20 years? Today, we look at corporate results every quarters. Few investors have stayed invested for over 80 quarters. In this period of 20 years, there were more than three scams, more than five cycles of euphoria and pessimism, multiple government changes and currency fluctuations.

Despite the odds, investors still made returns in excess of 38 times in a particular scheme of an equity mutual fund investment.

In direct equity, there are stocks, which have delivered returns ranging from 4x-30x in the last decade. A 15% CAGR growth in share price over the last 10 years means a four times return on the original investment. Little over 40% CAGR growth in share price over the last 10 years means a 30 times return on the original investment.

While 40% CAGR growth stories are rare, 15% CAGR growth has been delivered by handful well-known large companies listed in the bourses. How many of us have been able to see this wealth creation in the portfolio? Not a majority, of course.

Why is it that the retail investors miss out on these opportunities? The answer lies in the process and our behavioural biases. Recency bias, which means that events of the recent past get accentuated while forming and executing decisions, is one factor. In such a scenario, the asset class that has delivered the maximum at a specific point gets more traction investment.

Investment decisions are made in real time and do ensure allocation to equity. One can start even with small investment of R1,000 a month. Track the investments at a frequency of every quarter or half yearly. Build an equity corpus — either in direct stocks or through mutual funds — which you will not need for over five years. Do not expect the portfolio to deliver 3x return in three years.

The investment process is basic and elementary and what creates wealth is your emotional quotient (EQ). Do the due diligence before investing and trust the investment as well as the investment process. Do course correction, if the premise and data points on which you invested have changed. If not, then stay put and you will be able to generate multi-fold returns.

By Brijesh Damodaran

The writer is managing partner, BellWether Advisors LLP

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