“No problem in judgment and decision making is more prevalent and more potentially catastrophic than overconfidence”–Plous (1993)

Psychologists have determined that overconfidence causes people to overestimate one’s actual ability, performance, level of control, chance of success or their knowledge and have excessive certainty regarding the accuracy of their beliefs.

Some examples from research literature include the following: students overestimate their performance on exams, physicians overestimate the accuracy of their diagnoses, people overestimate how much control they have, and people overestimate the speed with which they can get work done. And the list doesn’t stop here, In one study, 37% of one firm’s professional engineers placed themselves among the top 5% of performers at the firm. But perhaps the most humorous result is that 93% of a sample of American drivers and 69% of a sample of Swedish drivers reported that they were more skillful than the median driver in their own country.

People are overconfident. Period.
But, “I am different”, I hear you say. Well let’s test it out. Without Googling, answer this question honestly,
“How long is the Nile River?” 1. 2.. 3… 4…. 5 seconds and you time is up.
Now, how confident are you in your answer? Again 1. 2.. 3… 4…. 5 seconds

Time to check the correct answer… its 6650 km.

Research shows that participants estimate 90% confidence intervals around their answers. And these confidence intervals are too narrow, suggesting that people are too sure they knew the correct answer; 90% confidence intervals contain the correct answer less than 50% of the time.

People, including you and me, are overconfident. Period.

For an investor this translates into taking high risk bets and excessive churning of one’s portfolio or excessive trading in the markets. Well what is the remedy then? Again the psychologists provide the answer through a thought experiment, which goes like this,

You have decided to invest in a stock and you have given yourself a period of 5 years for it to double in value; In which of these scenarios would you be less confident?

Scenario 1: You will be put in a time capsule and immediately flown to the future target date of your investment, so that you can actually check its value.

Scenario 2: You will have to wait 5 years for your results to be known.

It is understandable that you will be less confident in the first one. Why? The thought of knowing the results immediately makes us underconfident about our judgement and reasoning. What was so sure a moment ago is now full of doubt. By employing this simple hypothetical ‘shorter time-lapse’ between decisions and results, we can cure ourselves of overconfidence.
The next time when you are making a financial plan to fulfill your life goals (your daughter’s wedding or your son’s college education), fast forward to the future point of time and visualize the actual event happen and then just think “What if?” and find answers to all the possible scenarios including the best and the worst case.

By now, you are hopefully cured of the overconfidence syndrome and ready to make a decision.

Just a minute… How about double checking whether the medicine has actually worked? Try answering these questions with a high and low estimates, so that you are 90% certain that the true answer lies somewhere in between.

1. What is the weight of an empty Boeing 747?
2. What is the diameter of the moon?

And now its time to Google and check your result

Further reading,
The Danger of Investor Overconfidence

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A big limitation with most of the financial products is that the benefit would be felt or enjoyed many years from the date of purchase. When you buy an insurance plan or a mutual fund whose performance is market linked, it is only years later would you know how well or badly it has performed. Of course fixed income products like bank deposits or postal deposits let you know upfront as to what you can expect. But with everything else including gold, life insurance, real estate or mutual funds, the results are certainly unclear.

This uncertainty in results due to the very nature of these products makes them extremely fit candidates for mis-selling. Salesmen promise, even explicitly sometimes, extremely high returns on such products knowing full well that the real time of reckoning, that is the time when the returns would be actually measured, is a distant reality. It is always possible to blame the market, the company, the economy and what not as their escape route. Here is a case of a famous actress / singer being taken for a ride by her bank. You can well visualize her plight. And she’s certainly not alone. There are thousands of others like this gentleman who are suffering in silence.

But who is to blame? Yes, the persons who take the hapless clients for a ride, most certainly. But is that all? How about the client himself / herself? Has she taken enough interest to educate herself of the basics of finance? You do not have to be a doctor to take care of your health. Awareness of fundamental hygiene, diseases, prevention, first aid etc is sufficient. Similarly you do not have to be a Phd in finance. Just enough knowledge to ask the right questions and sound knowledgeable will put the salesperson on notice and he would think twice before uttering a word. But alas, isn’t money management so old-fashioned and dull thing to learn in this age of wealth management, portfolio management, privileged customer, private banking etc.

Whenever something offered on a financial product sounds too good to be true, quite possibly it is. This should straight away put you on high alert. Yes, higher return does require higher risk. But the problem arises when the vice-versa is also taken for granted. That is, assuming higher risk always results in higher return. It is not so. Return from a financial product is a function of the market that the product invests in. If it is an equity MF, then its returns will in some way be determined by the Indian stock market. It is not normally possible to promise a return that is totally out of whack with the underlying investment. Yet how often do we hear of money doubling in 3 years or turning 5 times in 10 years etc? It does sound tempting when offered such an attractive proposition. But stepping back just for a minute to take stock of the situation would eliminate most of the rash decisions that we tend to take impulsively.

Normal returns offered by relatively safe and stable financial products presently available in India will serve the purpose of most. We only need to understand the benefits of compounding over long periods of time to find our real way to wealth. We tend to hit the two extremes of the risk spectrum. That is, we are either too risk averse and conservative or we just tend to throw caution to wind and act recklessly. Investing has to be a balance of risk and return, liquidity and growth, rationality and emotions.

So the next time you are offered the moon, beware. Even if it is shown as delivered, you may not be in a position to enjoy it as it would remain just an illusion.

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Investor behaviour still seems to be influenced by past experiences and perceptions, especially of the stock market, though the investment environment has seen a sea change over the years.

Why are children generally afraid to sleep alone in the dark? Because they fear an imaginary creature, call it a monster, hiding under their bed or in the cupboard! This is an instinct that we humans seem to have carried right from our days as hunter-gatherers when these monsters were very real, in the form of wild animals. And lonely children made very good meal for those monsters. A proximate adult provided the much needed security and comfort to the children.

But why do children still have that same fear when we now live safely away from wild animals in the cosy comfort of our bungalows and apartments? Psychologists explain this behaviour by a theory called “Evolutionary mismatch”- a behavioural mismatch between the environment that our distant ancestors lived in when our genetic personality was shaped and the environment that we live in presently.

Wikipedia has the following to say on this theory: “The essence of mismatch theory is that organisms possess traits (including behavioural, emotional, and biological) that have been passed down through generations, preserved by natural selection because of their adaptive function in a given environment. However, the given environment of the evolutionary period can be quite unlike the current environment. Therefore, traits that were at one time adaptive in a certain environment are now “mismatched” to the environment that the trait is currently present in”.

But what has this got to do with finance? Well, there seems to be a striking resemblance between our behaviour as investors today and the child’s behaviour mentioned above. Read on.

Most from the previous generations would swear that stock market is a dangerous place to put one’s money. They would strongly dissuade their children and grand children from “gambling” in stocks. They would advice that money be put in safe bank deposits, gold post office and endowment policies. Are they wrong… or do they have a point after all? Well, to be fair to them, their investment experience was shaped in a totally different environment in the past.

The Indian investment environment THEN…

Deposits then provided double digit returns, in the range of 15 to 18%. Comfortable positive real returns were not a problem. Gold price was not exposed to the vagaries of currency fluctuations. There were no structured derivative products on commodities… so no major scope for speculation. Land provided a small but steady return, primarily from agricultural activity. There was not much of commercial real estate activity then. Housing loans were a taboo in a capital starved economy. Again, there was not much of speculation and hence a minimal chance of losing money.

There were stock brokers only in big cities. Shares were traded in the open outcry system. Brokers in the ring would scream at each other, bidding and selling, not many could hear each other. Buying and selling stocks for an individual investor was quite an effort. One never knew at what price the broker really bought or sold his shares. It would always be loaded against the small investor. There were no screen based trading like now. Share market remained a mystery to many and hence out of bounds. There were not many Mutual Funds and the lone PSU MF had more of assured/stable return schemes. There were no systematic plans that could help manage risk or automate investment process. Information was at a premium then. Share market news always arrived with a time lag. Analysis was difficult with no computers around. Regulatory monitoring and intervention was minimal due to technological constraints.

The Indian investment environment NOW…

The environment has changed quite dramatically by now. There are no deposits that offer high double digit returns now. Inflation could easily outstrip the fixed income returns of today. Gold prices today swing to the tunes of the international investors, hedge funds and ETFs. Currency volatility could easily take the sails out of gold. Real estate has become largely speculator driven. Land mafias are omnipresent. Shady operators have developed a soft corner for this “ever appreciating asset” which has also become a safe haven for their ill gotten black money. Land records are outdated and incomplete thus casting uncertainty on titles. Land grabbing and frauds have become common place. Investors, for some strange reason prefer to ignore these very real risks to their “safe” investment assets. They seem to be resting in the past comfort and laurels of these asset classes.

But on the other hand, stock markets in India have now become much more transparent and accessible. There are trading terminals in every corner of the country. Prices and trading patterns now are highly transparent and information is available at their finger tips. Stock investing can now be done from the comfort of one’s drawing room. The stock exchanges and the regulator have put in decent risk management and investor protection measures. No doubt, there is always scope for improvement.

Mutual funds now offer tremendous variety and flexibility with their systematic plans, index funds, diversified funds, market cap funds, sectoral funds, P/E based funds, asset allocation funds, triggers etc. Investors can now tailor an investment program that suits their unique need and comfort. One can put in money daily, weekly, monthly or quarterly to minimize risk. Similar convenience is available in redeeming or switching between debt and equity according to pre-determined formulae. Managing market volatility and minimizing risk therefore doesn’t need much of an effort now. The possibilities today are simply enormous.

But investor fears have remained the same…

Though the investment environment has change quite dramatically over the years, investor perceptions haven’t really evolved with this change. Investors still tend to underestimate risk with other asset classes and overestimate the same for equities, based on historical experience. They seem to have the same old fear towards the stock market. They conveniently stick to postal schemes, endowment plans and bank deposits; never mind if they destroy wealth over time due to the evil of inflation.

Investors seem to fear the imaginary monster in the stock market, like the children who are afraid to sleep alone in the dark. Their fear seems to be largely perceptional, if not totally unfounded. Millions of pages have been written and words spoken on the wealth creation potential of equities. But investors do not seem impressed by and large. They are immensely influenced by the perceptions and experiences of their previous generations. No wonder just about 2% of Indians invest in equities when foreigners are flocking to our markets.

But, is the stock market so very dangerous?

The stock market is no doubt volatile in the short term and more so in the recent past. The gyrations have been swift and sharp. No wonder the investing legend Benjamin Graham said “Stock markets are like voting machines in the short term, but are like weighing machines in the long term.” Take a look at how investors have voted in the short term (highlighted by the circles in chart 1 below) where the pattern resembles that of an Electro Cardio Gram (ECG), reflecting the fluctuating market pulse.

Chart 1. Source: NSE

But when viewed over a sufficiently longer time frame, a clearer trend on the market behavior emerges and it has been clearly up. Just as the earth looks flat when viewed from a short distance, the stock market looks manic over shorter time frames. One would need to move sufficiently far away to understand the real shape of the earth and also the stock market trend. The following chart 2 incorporates a trend line to the market movement and one would agree that it is convincingly upward sloping.

Chart 2. Source: NSE.

Over the longer term the stock market has indeed acted as a weighing machine, reflecting the true economic progress of the under-lying companies. A share is after all part ownership of a company and the share market, a slave to the performance of its constituents. Volatility in fact is a friend of a long term investor and an SIP would give more bang for the buck during such volatile periods.

Conclusion

Equity is the truly wealth creating asset for investors and sadly it forms only a negligible portion of their net worth. The adverse effect of lack of equities in their portfolio would show up glaringly over the long term when the cumulative impact of wealth erosion would severely erode their purchasing power. Investors would do well to consciously overcome this perceptional aversion to this wonderful asset, especially in a growing and high potential economy like India. A carefully planned and fully understood stock market investment program has the potential to make a huge difference to investors’ wealth levels over long investment horizons, courtesy the power of compounding.

And yes, investors can rest reasonably assured that there’s no monster under their bed!!

V.Sreekant, CFP^CM

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Rajesh is a keen footballer. Has a lot of interest for the game, works hard and tries his best to score goals. But he has not progressed as much as he would’ve liked in the game as he hasn’t scored as many goals as would’ve been needed for him to progress. So he thought of a novel way of scoring the goals. Instead of taking the effort to get the aim correct towards the goal post and the pain to kick it all the distance, he now has people to move the goal post in the direction that he kicks the ball. And his success rate has increased quite tremendously ever since!

Well, do you find this approach by Rajesh amusing? Do not laugh yet because most of us have been following this very approach in our financial lives. Yes, instead of setting the goal and trying to put the ball into it, we’ve been doing our best and then drawing the goal post around the ball. How?

A goal is a well defined target that does not ordinarily move. It is the players’ skill and effort that takes the ball near or into the goal post. This clearly implies that a goal is rigid and we need to adopt our strategy towards achieving it. But are we doing it with our financial affairs?

The logical way of investing would be to set SMART financial goals and strive to achieve the same. The goal could be a) Accumulating Rs 25 lakh by 2020 towards your daughter’s wedding or b) Achieving a retirement corpus of Rs 200 lakh by 2030. In such a case it is clear about what is to be achieved and you can tailor your plan / strategy / activity to achieve the same. But is this what most of us tend to be following?

Fixed goals are so inconvenient you know, because they can show failures. So we simply believe in doing “our best” for our family and also take pride in the same. But instead of fixing what we want to achieve with our money for our family and then working for the same, we adjust our affairs according to the financial position prevailing at the time. So if the financial position doesn’t allow the daughter an MBBS degree, put her in a nursing college. If the son’s BE cannot be afforded, make do with a diploma. The same goes for wedding. Settle for the groom’s status that the present financial condition allows, irrespective of whether the daughter will live happily there for next 50 years or so.

And then finally, compromise on the retirement lifestyle too according to the income that the residual assets generate after all these expenses have been taken care of. Doesn’t matter if that expensive surgery at age 70 has to be skipped for want of funds. Never mind if that old car is giving constant head aches. It cannot be replaced because of tight money conditions.

Our mind has been set towards doing “our best” and then compromising on the outcome. There are some compromises that may not make a big impact either on us or our family members. But for the other important financial responsibilities, it is very important to decide before hand about what is to be achieved and then make steady progress towards the same through time because any compromise on these outcomes is likely to have a lasting and perceptible impact on your / family members lives for a long time.

Doesn’t the idea of moving the goal post sound strange and funny? Give it a thought. And do post your comments.

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Posted by Sreekant on 19-01-2012.

It’s been quite a while since I wrote a blog post. Well, I was caught in the “Thane” cyclone and life was dislocated for a while. I was however lucky than most others in this area as my suffering and damage was much lesser than what I witnessed around me. My heart goes out to the families affected by this very severe cyclonic storm and yes, I have done my bit to alleviate their suffering. People have lost their roofs, cash crops, cattle etc.

My recent experience made me write this post. Good and bad news awaited me in the aftermath of “Thane”. The bad news was that there was some damage to my properties which would cost a fairly large amount to restore. But the good news was that I was not needed to pay for the repairs and renewals from my pocket! Yes, some of the teak trees that my father / grandfather had planted more than two decades ago were uprooted by the storm and they had to be cleared and sold. Even the partly damaged teak fetched a sizable amount and that too in the present depressed market (millions of trees have fallen in this area and all of them are hitting the market), sufficient to repair the damaged property and hopefully leave a surplus too. Well these trees were fully in my sight all these years but did not attract my attention for any reason. They were planted and cared for initially after which they needed no further care or attention. They grew by themselves and provided me a lump sum after so many years.

I am also reminded of an anecdote that I had heard a few years back. An elderly marwari gentleman passed away leaving a lot of incomplete financial transactions. When the family set about closing those transactions, they were faced with a huge deficit. Obviously some of the receivables were not properly recorded by the elderly man and those who owed money kept quiet conveniently. The family was crestfallen as their family dignity and future life were at stake. After some time, thought and much hesitation, they decided to sell their house to settle the pending transactions. While they were disposing off the unwanted articles, a steel trunk that had been lying abandoned and uncared in a corner of the house needed to be disposed. When they broke it open, they were greatly surprised, in fact pleasantly shocked to find a few thousand shares of Infosys in physical form bought at the time of the IPO!! You can well guess how those shares would’ve helped the family at their time of crisis.

The similarities between my recent experience and that of the marwari family seem striking. A wise action / investment made many years ago and left undisturbed has grown tremendously over the years and made a perceptible impact on the owners. Well that is the power of equities and they are like the teak trees that grow into a fortune over time. If those trees are disturbed every now and then or are cut prematurely to realize the profit, their true potential is wasted. A good equity (shares) investment held for a few decades could well change the financial fortunes of the investor and his future generations. All that it requires is patience and conviction. If you are going to doubt continuously whether the teak would in fact grow into a giant, then there is every possibility that you would disturb / destroy it.

It is in the Indian culture and ethos that we look to leave a fortune to our future generations, even if it meant sacrificing a bit of our lifestyle. The simplest way that you can achieve this fortune is by buying shares of good companies (of course at the right price) or units of good diversified mutual funds and leaving it undisturbed for decades, possibly away from your and your family members’ view. You can rest assured that they would come handy to your loved ones at times that are good or bad.

And yes, if you have the space and inclination, do plant a few teak trees and care for them in the first few years. They will surely add to the wealth of your future generations without much further effort!

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From January 2011 till now the Nifty is down 27%, and an investor saving for retirement in a SIP has nothing to show but losses. And I am pretty sure some one just started on such a plan would be wondering, “Am I doing the right thing?”. Well let’s explore this, by drawing heavily on the wisdom of Ben Graham from his book “The Intelligent Investor”,

“No one has yet discovered any other formula for investing which can be used with so much confidence of ultimate success, regardless of what may happen to security prices, as Dollar Cost Averaging.”

– Lucile Tomlinson, as quoted by Graham.

Even Graham admits that this is a striking observation by Miss Tomlinson. By choosing to invest through a SIP, an investor is on the right track. But, how to be prepared for losses? And that is the next aspect we will explore,

“Common stocks may do better in the future than in the past, but they are far from certain to do so. We must deal here with two different time elements in investment results. The first covers what is likely to occur over the long term future–say, the next 25 years. The second applies to what is likely to happen to the investor–both financially and psychologically–over short or intermediate periods, say five years or less. His frame of mind, his hopes and apprehensions, his satisfaction or discontent with what he has done, above all his decisions what to do next, are all determined not in the retrospect of a lifetime of investment but rather by his experience from year to year.”

–Graham, chapter-The investor and Inflation.

Investors of today, read the above sentence twice or as deemed fit, till you can recite it, if suddenly woken from sleep. Now this is the time for you to define the reason and purpose of investing–preservation of purchasing power of your dollars earned in youth as you retire. Or investing to get rich. Or somewhere in between (What To Aim For). If you are looking at your investments as Jack’s bean stalk, to grow instantly, to help you in achieving your desired objective, then losses in your portfolio will be a cause for panic, as there is a mismatch between your time frame and your investments.

WHAT COURSE TO FOLLOW

“Investors who for some time have been following a bona fide dollar-cost averaging plan can in logic elect either to continue their periodic purchase unchanged or to suspend them until they feel that the market level is no longer dangerous. We should advise rather strongly against the initiation of a new dollar-averaging plan at the late 1964 levels, since many investors would not have the stamina to pursue such a scheme if the results soon after initiation should appear highly unfavourable.”

–Graham, chapter-A Century of Stock-Market History.

Do you have the stamina to see a further 25% loss or still worse, as you keep investing through 2012? Answering this honestly will give you the answer to the title (of this article), Will You Retire Rich? And I will end with this,

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgement is sound, act on it–even though others may hesitate or differ. (You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.) Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgement are at hand.”

–Graham, chapter-”Margin of Safety” as the Central Concept of Investment.

May you be blessed with courage.

Happy New Year!

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But since then, a lot of water has flowed and there is a perceptible change in Indian economic landscape and hence the interest rate outlook. RBI in its mid quarter review on 16-12-2011 has left the key monetary parameters unchanged and also indicated that it may have to look at reversing the policy stance given the drastic deterioration in our economic activity. IIP, GDP, exports, credit growth have all shown an appreciable slow down indicating weaker economic activity ahead. RBI wouldn’t risk increasing rates any further and the next movement could well be downward, whenever it happens.

We may hence safely assume that interest rates have peaked out in this cycle. This assumption would hold good as long as we do not encounter any unforeseen events like a nasty run on the rupee or a huge additional borrowing / spending program by the government etc.

Having assumed that interest rates have peaked out, what should we as savers, investors, and borrowers do in this scenario to maximize our benefits / minimize our losses? Read on…

Savings: Saving should never be a function of interest rates. The habit of saving before spending should be followed at all times and the present time is no exception. Saving may appear a bit foolish when the real interest rates are negative but still that shouldn’t be an excuse not to save.

Investing: Interest rates impact different asset classes differently and need to be handled separately.

Bank interest rates have peaked and may start sliding in due course with poor credit demand. A lot of bank money is going to government bonds now.  This is a very good time to lock into long term deposits at these interest rates if you do not need the money in the interim. For a temporary need, you may always raise a loan on your deposit. It may take a while for these high interest rates to re-surface once the tide turns. Avoid floating rate deposits.

With postal schemes too now moving to market linked returns, these rates also may be headed down in the years ahead. But as these rates are lower than the corresponding bank deposit rates, they do not look all that attractive presently.

Mutual funds: Different types of funds react differently to interest rates.

Interest rates and bond prices are inversely correlated. That is, the price of a bond goes up when interest rate falls and vice-versa. Now that rates seem to have peaked, you may consider entering medium to long term bond funds or gilt funds which would give very attractive returns when interest rates slide. Yes, there will be a fair amount of interim volatility and these funds may even produce a capital loss if interest rates go up unexpectedly. You should consider these types of funds only if you have the risk appetite / tolerance and time horizon of at least 3 years. Go for short term funds if your investment horizon is uncertain.

You may also consider Fixed Maturity Plans (FMP) to lock in to these attractive rates. These funds come with varied maturities ranging from 3 months to 3 years. Depending on your horizon, you may pick a suitable fund. Avoid floating rate funds now that interest rates look to be headed down.

Equities are also fairly attractive for long term investors though the market may go further down in the short term. Market timing is a futile exercise and not worth the effort. Instead, you may simply put any lump sum that you may have in a short – medium term bond fund and systematically transfer a fixed amount in to an equity fund to average cost. Over the next 7 to 10 years, you would be glad you did it. But do not make the mistake of stopping any ongoing SIPs. This is a good time to average down your acquisition costs.

Borrowing: The first red flag for borrowers is to avoid locking in to these high rates through a fixed rate loan, especially a housing loan. Banks would push these products really hard as they know these rates wouldn’t hold for long. Some banks are smart enough to offer a fully fixed loan for 20 or 25 years now when all this while it was fixed for only about 5 years! If you are very keen on taking a loan at this point in time, go for floating rate loan which are now more transparent with the advent of base rates. If it is a non-essential borrowing, you may look to postpone it for a better time.

“Predict either the rate or the date, never both” goes a saying. Interest rate predictions are as difficult as predicting the stock market movement. Too many factors play a role in determining the interest rates. So we can only make an informed guess on the interest rate direction which could well go wrong. So be prepared for the worst case scenario of an interest rate hike too!

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We want to make money. Obviously.

Also, we need to make more money than the next-guy. This too is quite obvious.

But why?  What is driving this behavior? Below is the research from which I draw my observation:

MONKEYS TO HUMANS

“A lesson emerges from a classic experiment conducted by Franz de Waals and Sarah Brosnan. The primatologists trained brown capuchin monkeys to give them pebbles in exchange for cucumbers. Almost overnight, a capuchin economy developed, with hungry monkeys harvesting small stones. But the marketplace was disrupted when the scientists got mischievous: instead of giving every monkey a cucumber in exchange for pebbles, they started giving some monkeys a tasty grape instead. (Monkeys prefer grapes to cucumbers.) After witnessing this injustice, the monkeys earning cucumbers went on strike. Some started throwing their cucumbers at the scientists; the vast majority just stopped collecting pebbles. The capuchin economy ground to a halt. The monkeys were willing to forfeit cheap food simply to register their anger at the arbitrary pay scale.” (Does Inequality Make Us Unhappy?)

When the market doles out more returns for the next guy (even though we don’t see his efforts), we are not amused. So, the real reason we are searching for the best investments (at-least one of the reason among others), is not that we want to squeeze out the maximum from the market, but we don’t want to end on the inequality side of  market returns (which is actually quite similar to the researchers arbitrarily giving some monkeys grapes and others cucumbers).

Some are so paralyzed by this, though it is not so self evident on the surface, that they refuse to play this game altogether (the plethora of investing options also aides in this inaction), and invest their money only in Fixed Deposits of banks, where they are assured of equality (Ambani will at most get a fraction better for his FD than yours!!).

My RADICAL Solution

I would recommend to ban all stock Mutual-Funds, and the only one allowed would be a Total Stock Market Mutual-Fund (a Bond Index Fund would be allowed too) in the style prescribed by John Bogle:

“Our industry began, then, with the formation of a truly mutual mutual fund, one organized, operated, and managed, not by a separate management company with its own commercial interests, but by its own trustees; compensated not on the basis of the trust’s principal, but, under traditional fiduciary standards, its income.”

Why? With the myriad of schemes gone and having only one option to invest in (including to your brother-in-law), we have less chance for harm, and below are some of its advantages:

1. Low cost : As a fund owned by the investors, for the investors the cost can be kept very low.

2. Minimize risk of wrong portfolio selection : There is no hot sector or manager to follow and get burned in the end.

3. Paradox of choice : More choices may lead to a poorer decision or a failure to make a decision at all.

4. Right investment approach: Investors now act as investors and begin to focus on investment-returns (as opposed to speculative-returns, which was the gripe previously).

5. Investor satisfaction: This arrangement now is similar to an FD (has the same psychological make-up), only difference being that returns are determined by the market instead of being fixed.

INDIA IS A DEMOCRACY

Do we need to go to the extreme step of banning all other investment funds, to achieve this desired objective?

Governments in Europe and America have started to use Behavioral Psychology, and UK has gone one step further by setting up a Behavioral Insight Team (NUDGE Unit), with the aim,

“To change what people do, not by coercing them, but by altering the way the options are presented, and making it easier to choose the best one.”

Think about this. Psychologically and also financially, this is in the right direction.

But, is any one (politicians) listening.

Further Reading :

1. (From the 2004 Berkshire Hathaway Shareholder Letter) “Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous. There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

2. “What’s Wrong With Mutual Funds” – John Bogle. (A great interview on Forbes On-Line)

From admin: This is our 100th blog post and it has been quite a journey in the past 18 months. We thank all our readers for their support and encouragement.

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And this technology has touched our financial lives too equally profoundly. The way we spend, invest, transact – everything has changed beyond recognition. Gone are the days when we had to send an outstation cheque for collection and wait for days together to realize the funds. As an economy too, India has benefited tremendously from technology without which IT & ITES, the prime movers of our economic activity today, wouldn’t have been possible. Salary levels and consumer behavior have undergone a sea change in this new economy.

But how has technology impacted our financial behavior as individuals? Here’s an analysis of how transacting, spending and investing habits have evolved with technology.

1. Transacting: Money today travels at the speed of light, if not faster. In a matter of seconds it has traveled across states, countries and even continents thanks to technology. RTGS / NEFT, net banking etc have transformed the very concept of money and transactions. This no doubt is a boon for consumers as they are relieved of the pain that they earlier used to suffer.

2. Spending: As detailed above, transacting for expenses has become that much easier. Gone are the days when you had to reach the bank before the closing time, stand in the queue to draw cash, putting up with the rude behavior of the cashier. We now have the ATM, credit card, debit card and other such instruments that have made “cash” irrelevant. We also have e-commerce, m-commerce etc. Will the next step be t-commerce? (Paying by telepathy ). Money is at our fingertips 24/7/365. Bank holidays have become irrelevant.

Unfortunately these latest facilities seem to have made us spend more because the effort involved in transacting has almost vanished. You can just swipe your card, pay online etc 24/7. Earlier we had the constraint of carrying and drawing cash which acted as a natural restraint on our spending habits. But now we don’t feel the pain of paying with hard cash. Moreover internet has made shops accessible 24/7 and you don’t have to worry about business timings too anymore. So technology has in fact proved to be bane for our spending habits, especially for the undisciplined.

3. Investing: Technology has also revolutionized the way we invest now. We can now book an FD online, make an MF investment online, trade shares online and even pay insurance premiums online / using debit card. The investor interface has moved beyond the computer to the mobile handset now. Many investment options are now open over the mobile phone. Investment activity has been greatly simplified and quickened. Gone are the days when you would place a buy order to your stock broker hundreds of miles away and wait for days for that to be executed. Your transactions now are executed in a matter of minutes and seconds. The human interface has almost vanished too.

But Investment, as you would agree, is a well planned and carefully constructed financial activity. It requires considered decisions and actions. The advent of technology may just have inadvertently brought an element of impulsiveness into our investment activity. The ability to execute instantly and the lack of human intervention may have increased the occurrence and possibility of rash and emotional investment decisions apart from encouraging frequent churn.

In the absence of technology, an investor may have called up his advisor, expressed his anxiety and discussed the situation before redeeming that MF or selling the share or switching his ULIP fund at times of general market panic and investor specific situations. But now the impulsive act may be to transact first and then discuss with the advisor.

“Lethargy, bordering on sloth should remain the cornerstone of an investment style” said Warren Buffet. A good investment discipline seeks to minimize transactions which in turn reduce errors, emotions and costs. But advent of technology seems to have made us transact more and without much thought on our investments. So technology may in fact be a bane for financial consumers in this aspect.

Technology is in fact a double edged sword. For the wise and prudent it has simplified life. For the others it has encouraged recklessness and brought financial ruin. It is up to us to adopt / adapt to technology in our financial lives to the extent that we find useful and comfortable. Technology being a boon or bane in effect depends on individuals and their habits.

What do you feel and what has been your experience in this regard. Do share you views.

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(CHART 2: SENSEX)

(CHART 3: Assets Under Management)
(Source : AMFI) 

Searches for the word ‘mutual fund’ (Chart 1) peaked with the rise (beginning of 2007 to late 2007) in Sensex, and drops off (from 2008) subsequently with the market (Chart 2). Investors have also voted with their money, as is evident in the last chart (Chart 3), where they have poured money into the markets as they were rising and subsequently have withdrawn, as the markets have been falling.
Is this behaviour not typical enough to label mutual funds as a Giffen good.

What does this say about our (investor) behaviour? And what can we learn from this?
Give it a thought.
( p.s. As of this writing the average assets under management of mutual funds for September 2011 are 712741 Crores and the SENSEX is at 15700)

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