Invest in your common sense

If the problem of choosing companies is to be replaced by that of figuring out whether one should invest in this exotic idea or that one, then nothing much has been achieved.

Dhirendra KumarI have been answering people’s questions about investing for many years now and frankly, I have probably learned more about investing from those questions than from anything else.

The apparent sophistication of investing questions forms what a statistician would call a double-hump curve. On the one hand there are people who are grappling with very basic issues. They are trying to figure out what NAV is and whether a mutual fund can guarantee returns.

At the other extreme are those who are completely immersed in the jargon of funds and whether they understand it or not, are convinced that the more complicated an investment strategy sounds, the better it must be. The idea is that as in cell phones or cars, features are good and more features are even better. This lust for features extends to financial products as well.

I strongly believe that keeping things simple is the key to making the right investment decisions. I’m not just saying that simplicity is desirable, but that simplicity is mandatory. The more complex a financial product or service, the worse it is for the buyer.

If an investor does not understand a financial product or service, then it isn’t right for him, regardless of how attractive it may otherwise appear or may actually be. The investment process starts not with investing, but with the setting of a goal. This may sound suspiciously like something out of a self-help book but is very necessary.

I often get heartbreaking emails from investors with completely unrealistic goals, like looking for a way to turn Rs 5,000 a month over five years into Rs 15 lakh. This is not going to happen no matter how much the investor wants and needs the Rs 15 lakh. Setting an investment goal is as simple as it sounds. Try and predict when and how much money you would need in the coming years. Sure, the future is uncertain and many things can’t be predicted but it’s good to have an estimate of what is needed when. Then work out how much you need to save to achieve your goals. After this comes the most important part—to actually save the money so that it can be invested.

I’m not being flippant here—we all know how despite the best of intentions, one saves less than one can. A good way of saving is to automate the process. All mutual funds offer systematic investment plans (SIPs) under which a fixed amount is invested every month. The biggest advantage of SIPs is that they enforce investments. Believe me, more people have problems because they don’t save at all than by saving in a sub-optimal option.

Then comes the issue of where to invest in. The simplicity mantra is very useful here. All investments are of two types—debt or equity. You may have heard of dozens of different kinds of funds but that’s all marketing hype—at the end of the day, it boils down to debt or equity. Deciding how much to invest in each is what is called asset allocation and like everything else, it can be made very simple. Keep money you would need in the next 5-7 years in debt and everything else in equity. There are far more complex approaches to deciding asset allocation but I doubt whether any of them yield better results.


GOAL SETTING: All investments must have an objective. Set goals and then save to achieve them
MINIMALISM: Keeping things simple is the key. Stick to just two or three funds with a good record
AUTOMATE WITH SIPS: Despite best of intentions, one saves less than one can. Autoinvest via SIP
ASSET ALLOCATION: Invest what you will need in next 5-7 years in debt and rest in equity
MONITOR AND REALLOCATE: Review and reallocate to maintain balance between debt, equity
After this, you need to choose the right funds. There’s a strong need for minimalism in investment planning. The very opposite is happening right now. The loudest messages about investments and savings that reach people are advertisements of new mutual funds. They try to promote the idea that your investment needs are best met by portioning out little bits of your savings into several exotic and specialised mutual funds.

The collective impact of this marketing message is an investor who is desperately trying to figure out a portfolio that will perhaps consist of about 30-odd funds with 3-5% allocation in each. That’s not an exaggeration. I have seen people whose portfolios contain more than a hundred funds, most of them less than 1% of the corpus. People buy into the sales pitch of brokers and invest a few thousand rupees every time a new fund is launched.

A mutual fund is meant to simplify things for an investor so that he does not have to figure out which companies to invest in. If the problem of choosing companies is to be replaced by that of figuring out whether he should invest in this exotic idea or that one, then nothing much has been achieved.

A portfolio of even 20 funds, each based on a different idea, is impossible to track. If you would like to be part of the minority of sensible investors, then you should stick to a minimalist approach. Choose two, perhaps three, general purpose mutual funds with a good track record and stick to them, leaving all other thinking to the fund manager.

If choosing the funds is important, so is the manner of investment. It is suicidal to invest jerkily in equity funds. Unfortunately, this is far too common, a very usual pattern being to invest large sums of money when the market is up. This is where the advantages of SIP come into play. Besides forcing you to invest, SIP investing actually boosts your gains in most situations.

If you invest a constant sum of money periodically, then you will end up buying more fund units when the markets are low and fewer when the markets are high. The arithmetic of SIP would ensure that your average purchase price is low. That brings us to the last leg of the investing cycle—monitoring your investments. Earlier, I spoke about asset allocation between equity and debt. The most important thing is to maintain the desired asset allocation between them. In other words, sell the category that has been doing well and buy the one that isn’t. This may sound counter-intuitive but is the best way to protect your gains.

And that’s basically all there is to it. You would doubtless need more information than there is in this column but not a whole lot more. The key is to understand that long-term investing success and safety does not come from following the exotic, hyper-marketed flavour of the day. Instead, it comes from understanding a handful of simple things and doing them diligently for years. And years. And years.

Dhirendra Kumar, CEO, Value Research