In the midst of the debate as to whether equity investing is a Science or an Art and many textbooks / experts declaring that it is a mix of Science and Art,, there has been a new dimension that has been added over the last few years claiming that equity investing is predominantly “behavioural”. Let me begin the topic by asking a question. Which among the below options is a better way to invest in equities?
1. Adopt a purely scientific way of study of the fundamentals of companies, perform high-end number crunching to select stocks.
2. Follow an artistic approach by trusting the gut / emotions in order to pick winners among large number of stocks available.
Does any one of them ensure success always? The answer is NO.
Even the best of research does not guarantee success and of course for the second option, you cannot get lucky always. There is a third option which increases the probability of being successful.
3. Invest in a diversified portfolio of mutual funds, regularly with a long-term view (with discipline), stay invested (with patience) despite volatility in the short term.
For adopting the third route, we need to conquer our behavioural biases.
Why is Discipline important?
The working life of an individual, typically spanning age 25 to 60, is the earning and accumulation stage and this is when one needs to allocate funds for specific goals. In this long time period there would be many ups and downs. The life journey will have professionals and personal victories and defeats. Victories get people to get more casual and less disciplined. On the other hand, defeats in life get people to get more and more pessimistic and hopeless. However, keeping all emotions aside, a disciplined investor would try and stoically think of his investment journey. It is easier said than done but yet worth the try. We should be disciplined and walk the investment path, which is slow moving and boring. However, not meandering from the path can surely mitigate problems.
The first question that arises is when to start saving. The answer is simple and it is “now” or as early as possible. Let us take an example explaining the power of compounding and the need to start early.
A person starting to invest Rs 10,000 per month from the age of 25 would have invested a total amount of Rs 42 lakh till he reaches the age of 60. Assuming a return of 12% p.a. compounding, he would have amassed a corpus of Rs 6.4 crore at retirement. In contrast, a person starting to invest Rs 14,000 per month from the age of 35 would have invested a total amount of Rs 21 lakh. But would manage to build a corpus of only Rs 2.6 crore at 12% p.a. compounding, when he reaches 60 years of age. This shows that a delay of 10 years can be very costly. Doing the above math is easy, but following it for 35 years requires military level discipline and the patience of a saint. That brings us to the subject of Patience.
The BSE Sensex, since its start in 1979, has grown at 16% per annum till the end of financial year 2018. During this time, investments over various 20 year cycles seen at the end of each financial year would have averaged a return of 15% p.a. We all know that this number is much higher than what a risk-free debt investment would have earned (Note: These are historical numbers which may or may not hold true while forming expectations for the future). Despite knowing this fact, most people do not commit investments into equities for a long period of time.
An investor who sees high returns in the 1st year of investing gets greedy, whereas an investor who sees a decline in value in the initial period gets fearful. These emotions play a big part in how the investor acts during the rest of the investment journey. A little bit of patience helps investors who have just started investing and are experiencing lower than expected returns. A great way to overcome these emotions is to invest through SIP or Systematic Investment Plans as the investments are spread over a period of time at different market levels. Thus, the most important virtue that any equity investor needs to possess is Patience, in order to stay invested irrespective of the ups and downs that the equity markets go through.
Take advice from an Investment Expert
We often take advise from our trusted professional, whether a doctor, a lawyer, a CA, etc. Investing is as important and one should not take things in his / her own hands. While the valued advice of an investment expert comes at a cost, it is often negligible when compared to the potential benefits and the costly investment mistakes one may make. As investments encompasses making asset allocation decisions, evaluating various investment options available, assessing the impact of taxes, taking care of emergency fund requirements and closely following macro-economic developments that may impact the portfolio, it would be wise to engage with an investment professional. Moreover, an investment advisor would help an investor stay firm on course tiding over short term market gyrations and not bowing to the emotions while making investment decisions.
(By Shyamali Basu, Senior Vice President & Head – Products & Marketing, HDFC Asset Management Co Ltd)