We are a cinema crazy country. What
our heroes & heroines wear & flaunt, become a craze overnight. You can get your “Aamir cap”, “Shahrukh coat”
or “Kareena salwar suit” which was
featured in a recent movie, in shops across town. You will find half the town
wearing the latest hot fashion, though!
Chasing the latest fads does not end
with our sartorial sense alone. Even in one’s finances, we tend to choose the latest,
hottest product. So, if all in office
are procuring a particular insurance policy or are going for some investment
plan, it becomes the basis of investment itself, without any further thought.
Thought is not given as to whether the product is suitable for them in terms of
the asset class, duration, liquidity, risk profile of the product, end use and
other factors.
The other fundamental problem is
that different products perform at different times. Fixed income securities give good returns
when the interest rates peak. But logically, when interest rates peak, economy
and it’s constituents – the businesses, tend to underperform due to the higher
cost of capital.
The right time to invest in an asset
class which displays up and down cycles is when it is down, not when it is at
it’s peak. Investors tend to invest when
the market is in the middle of a bull frenzy, which is like sowing seeds in the
middle of the rainy season. The crops
grow properly only if the fields are prepared and seeds sown well before the
rains so that the saplings are ready to receive the bountiful rains and grow in
lush profusion.
In case of products which are prone
to cycles like equity, real estate, property etc., it is very difficult to
divine the bottom point, at which to invest. The psychological aspect comes
into play here. When the markets are bottoming out, the investor expects it to
go down even further. But contrary to expectations when it starts rising, they
expect a dip again as the lowest level is their anchor now and anything above
that seems expensive. When the price has moved up and away, the investor
realizes that they have missed the boat. They wait even more. When the markets move
further and there is a frenzy, they come in. Soon after, the markets tumble as
they have come in at the height of a bull cycle. They retreat into a shell and
want to invest only in fixed income products from then on. Investments done at
the height of the markets take very longtime to recover. This happens as we
want to time the investments and want to chase only those that are giving good
returns, at that point. Paradoxically, we end up getting poor returns when we
are gunning for products that give good returns all the time!
Chasing returns like this will
ensure that one ends up buying equities, real estate, gold etc. at inflated
prices, as investors tend to buy when they are performing. Pulling money out
from “non-performing assets” like equities now and channeling them into
“performing” assets like FD, Gold, Real Estate looks like the path to nirvana.
Actually, they are setting themselves up for future failure.
Investing too much into fixed income
securities alone also exposes an investor to undue risks. Fixed income products
mostly do not give positive inflation adjusted positive returns. This means
that the corpus that one needs for any future goals will have to be accumulated
with higher savings contribution, to reach the same goal. Also, retreating into
the shell and not willing to commit resources to cyclical assets at the bottom
of the market ensures that they do not reap the rewards of the upcycle.
Equity markets, especially, are
driven by fear and greed. Investing
only when it is rising is a sure recipe for poor performance of one’s
portfolio.
Investing in products which are
doing well at that moment also does not address several other aspects that need
to be taken into account while investing.
The first is that one needs to know
why they are investing in a product – what is the end use for it. Without a
proper goal, an investment tends to be fuzzy.
A product invested without much thought, may be a long-term one like
property, but the requirement may come for it after a year. In such a
situation, there is a huge mismatch between the product characteristics and
it’s end use. Hence, one should at least classify whether a product is for
short-term needs or for the long-term goals. That way, one would invest in an
appropriately oriented product.
Secondly, one needs to invest for an
appropriate tenure. Some products offer good returns only over time. Correct
tenure for an equity product may be five years. Now, if it is invested for a
couple of years and redeemed, it may give poor returns.
The other aspect is liquidity.
Investing in PPF may be a very good idea for someone who is accumulating a
corpus for retirement. However, it may
not be suited if the amount may be required for daughter’s admission, two years
hence.
This is the classic problem. The
product may be good in a lot of cases but may not be useful if it is not
properly matched. It is like mating a low powered engine to a sports car. It is
just the wrong kind of engine for a sports car though there is nothing wrong
with the engine itself. It would be
perfectly at home in a small car.
The simple solution is to diversify
one’s investment basket. That way, one will not end up with one kind of product
alone and lose out on the potential that other products have. The other
solution is not timing the investment and investing across cycles and time
horizons. If one also rebalances assets and sticks to a predetermined asset
allocation, it will work wonders.
It requires guts to put in more
money into equities at the bottom of the market, like what Warren Buffett did
in 2008 & 2009. But, he is no ordinary investor. He does not chase fads. He
is after good investment propositions – which he got at the market bottom. Time
for us to learn from the master – that buying in times of distress is the
correct investment strategy and investing while there is a frenzy is a slippery,
glacial slope to nowhere.
Article published in Business Standard on 17/6/2012 by Suresh Sadagopan
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