Most people assume that successful investing has a secret formula to it. Investors who’ve consistently beaten the market and remained afloat when all about them went awry, are shrouded in an aura of mystique – even revered. But the truth is different. In reality, being a good investor is much like making a good club sandwich – just stick with the tried and tested basic ingredients, and don’t try to reinvent the wheel. Sticking to the right asset allocation, for instance, will trump chasing hot stocks in the long run. Similarly, investing systematically will eventually outperform the more exciting endeavor of day trading in futures & options. And a conscious management of taxation, fees and transaction charges will lend a serious fillip to your long-term savings. Here are four ways for you to become a better investor. They’re so simple, you can start as soon as you finish reading!
Mix ‘em up
Diversification. As an investor, you’ve probably heard the word a million times before. But are you getting it right? Unquestionably, timing the markets perfectly would earn you the best returns. But anecdotal evidence suggests that that’s hard – if not impossible – to do on a consistent basis. And this is where diversification comes into play. By spreading out your investments optimally across various kinds of asset classes, you’ll be ensuring that if one or more of them go south, the impact on your overall portfolio would be controlled, at worst.
Think of investment options, if you will, as a sumptuous breakfast buffet. You’ve got stocks, mutual funds, bonds, NPS, post office schemes and other options on offer. A good investment portfolio will aim to combine them in a manner that fits your long-term objectives and risk-taking capacity. While investors tend to dither constantly about when to buy and sell investments, research has proven that only 12% of long terms returns are attributable to market timing; the remaining 88% to investment asset allocation.
While well-diversified portfolios may lag all-or-nothing, fully loaded equity portfolios in bull markets, they prove to be a lot more resilient during bearish ones. As a very rudimentary illustration, consider a mutual fund investor who had invested Rs. 1 Lakh in Franklin India Bluechip Fund (a top performing mutual fund scheme) on 1st January, 2008. By 31st December the same year, his fund value would have plummeted to Rs. 52,000, as the markets fell firmly into the clutches of the bears. Another investor who had opted to diversify his investments between Franklin India Bluechip Fund and Franklin India Income Builder Fund (a debt oriented mutual fund) instead, would have seen his portfolio falling by 20% lesser. A year later, despite a spectacular 81% rebound in Franklin India Bluechip Fund, the diversified investor’s portfolio would have been up by 7% more than his one-fund counterpart’s.
Have a Rebalancing Strategy
Just as your sumptuous buffet would involve replenishing the more popular items on a periodic basis while taking the unpopular ones off the table, so would your portfolio asset allocation warrant a periodic refresh. Yet, evidence shows that very few investors have a well-thought-out rebalancing strategy in place.
Rebalancing works in two ways. First, trimming off investments that have outperformed others will help you to inculcate automatic discipline when it comes to booking profits, and to also reduce exposure to investments that have risen in value recently. Second, by adding more money to investments that have been relative laggards in the recent past, you’ll be improving the odds of increasing your allocations to them at the optimal point in their investment cycles.
While rebalancing may come across as a mundane task, it's tougher than it looks; since you’ll be fighting your own worst enemy – your own mind – each time you do it. It’s hard to cut back on the winners in your portfolio while showing faith in the ones that are tottering in the red; and yet, it’s a strategy that works in the long run.
To illustrate the impact of periodic rebalancing, let’s revisit our previous example of the two mutual fund investor. Twelve months in, his portfolio value would have been approximately Rs. 73,000, but the vagaries of the markets would have distorted his original 60:40 Equity: Debt asset allocation to 43:57. Had he rebalanced his portfolio back to 60:40 by switching Rs. 13,000 from the debt fund to the equity fund at the yearend, his portfolio would have been worth Rs. 1.1 Lakhs a year later, compared to Rs. 1 Lakh if he’d chosen to remain passive – a difference of 10% within just one year.
You may choose from a variety of rebalancing strategies. You could do it once a year or quarter on a set date, or based on pre-set triggers. You could even combine the two strategies and check your asset allocation on fixed dates, but rebalance only if certain triggers have been hit. Do keep transaction costs and taxes in mind while rebalancing, though.
Choose Discipline over Timing
Investors adopt a wide variety of approaches to actually deploy money. Some sit on the fences waiting for the most opportune time to invest, while still others tend to get caught up in the vicissitudes of the markets and invest not as a well thought out response, but as an emotional reaction. But in the long run, few tactics beat the act of investing systematically and taking advantage of rupee-cost averaging.
Espoused by many a value investor including the legendary Benjamin Graham himself, rupee-cost averaging involves buying a fixed rupee amount of a security; such as a stock, a mutual fund or even Bitcoin, on a fixed date each month or quarter - no matter the price.
Rupee-cost averaging solves the problem of being too afraid to jump on board an aging bull-market such as the one we’re currently in. Additionally, it saves you from the inevitable caprices of the equity markets, which have been known to notoriously turn on a dime. The rupee-cost averaging principle can be applied to both your regular savings and your lump sums. If you’ve been lucky enough to encounter windfall profits, you could choose to break it into twelve parts and invest them over a year into your target investment, instead of jumping in with both feet. For your regular savings, you could start SIP’s (Systematic Investment Plans) into Mutual Funds, or issue a standing instruction to your stockbroker to purchase a fixed Rupee amount of your target stocks or ETF’s, in a fixed percentage, on the first day of each month.
Watch Those Expenses & Taxes
Investment expenses are the proverbial “small leak that could sink a mighty ship”. While novice investors tend to completely ignore or downplay the impact that taxes and expenses could have on their long-term investment performance, ace investors adopt a more rational and conscious approach to it.
Brokerages, Commissions and Expense Ratios are three things you need to watch out for. As a principle, avoid purported “investments” such as traditional life insurance plans that take away a large chunk of your money up front and pay it to an intermediary. Ditto for stock market strategies such as BTST (Buy Today, Sell Tomorrow) that have a high turnover rate, resulting in hefty brokerage expenses and loads of short-term capital gains. If you do not require active trading or investing calls from your broker, opt for a discount broker who will fulfil your trades at a flat rate per trade, or at low rates ranging from 0.01% to 0.05%.
In the long run, high expense ratios associated with some Mutual Funds can erode into your returns. Some schemes operate at lower costs than others, owing to their leaner distribution structures, economies of scale, and lower operating expenditures. When deciding between two funds with similar long-term performance track records, opt for the one that has a lower TER (Total Expense Ratio).
Beware of taxation related gaffes too. For instance, choosing the dividend payout option in your debt mutual funds can lead to a straight up hit of 28.33% on most of your returns, regardless of your tax bracket. Repeatedly churning your stocks before a year is through will erode 15% of your profits – a number that can really add up over the years. Remember, plugging these seemingly inconsequential leaks by pinching the pennies can lead to significantly higher wealth creation for you over the long-term.