It has been a roller coaster ride for new investors who started investment into equities within last few years. First many were lured by the gains coming from small caps. However, it kept falling over 2018 & 2019. In year 2020, many have decided to give up stock investment or move to large caps since they have done well over last two years. The idea of today’s article was triggered after our interactions with many investors who are not sure if equity is the way for their wealth creation. Should they remain invested in small caps or invest in Gold. Should they buy real estate or should they shun equities and go for old favorite fixed deposits. There are just so many things brewing in their mind which can make them miss out on making money opportunities in future.
There is no exact science which way one should invest but it is a process which needs to be developed after considering all possible investment options available before oneself. Since the basics remain the same, we can provide you some framework to create your own model. Remember everyone is different and your own investment model has to be the one which suits you. Always try to have a clear approach and a simple to execute investment plan. Let’s go through the basics once again to clear up our mind (5-7 minutes read).
1. Choose Your Investment Horizon
The first thing one should ask is why am I investing. If the answer is really simple like making money, it is not enough. It has to be specific to a certain goal. Having a goal is like having an end station of your journey. Without an end station, your path can become zig-zag and you may end up wandering here & there and not reaching anywhere near to your goal.
Typical, goals can be as follows:
- Retirement: Non-negotiable goal. Everyone has to deal with old age and pension less society
- Child Education: Non-negotiable goal if you have children.
- Buying a House: Negotiable goal. Sometimes renting out a house is better than owning it. Consider house loan EMIs and commute time to office / school etc.
- Holidays Etc: Negotiable goal. It can be pushed further if one does not have enough savings at present.
Once you have your goals, the magical thing is that it will always give a sense of how many years and how much money will be needed to reach that goal. This helps to be aware of the investment horizon basis on which you can choose your investment options.
2. Choose Your Investment Vehicle
In this world there are plethora of investment options like stocks, mutual funds, short term trading (some ppl consider it as investment), currency, futures & options, fixed deposits, real estate, gold, antique, wines, precious metals etc. Each investment have their own risk – return profile attached to it. As an investor we have to choose which investment option works best for me and stick with it. Remember each investment option has certain merit for someone but it may not be applicable to you. However, to ensure you do not get lured by these options in future, it is advisable to gain some knowledge about all of them and assess which one is best for you. A lot of times, investors start with mutual funds then graduate to stocks and move on to short term trading which is followed by derivative trading (futures). You can see this progression is destructive as investor is simply chasing profit and any new idea seems like golden opportunity not to be missed. Hence, it is important that you are aware of all investment options and pick the one which suits you. Once chosen, stick with it without exception. As a general rule of thumb any investment horizon less than 5 years should consider fixed deposits or debt funds. Any investment horizon over 5 years can consider equities. For other investment options like precious metals or real estate, investor has to have a very good knowledge of the demand supply situation to make a profit hence these are very risky. Other options like future or options are too risky as one bad option deal can wipe out your gains made over years. Same goes for trading. These are not reliable options for making money on a consistent basis. Warren Buffet called them as weapons of wealth destruction. If you still keen on them, please remember no one has made consistent money from trading. Can you remember any rich and famous trader. Most names will be of long term investors like Warren Buffet, Ben Graham or even our own Rakesh Jhunjhunwala etc. These instruments are there since many decades but mostly they have not anyone tremendously rich. The better use of futures & options can be for investors who are trying to hedge their risk. At best, they should be used for hedging and not for wealth creation.
Narrowing down the investment options, we typically have equities, gold or debt (fixed deposits). Gold and fixed deposits are capital preservation options as they will shield your money from getting eroded by inflation. They will not multiply your money in real sense. Many investor do not know that bank interest rates are tightly couple with inflation as per RBI policy so there is no way you can squeeze more than 0.5-1.5 percentage above inflation. For gold returns over long term hovers around inflation mark (+/-2%) as well. Gaining 1% or 2% over years is not going to make you rich. So the only possible option left is equities where you can squeeze 7%-12% above inflation. Again to repeat if you have sufficient money which needs to retain its value, please choose fixed income and gold as you do not need to grow money but preserve it for immediate use.
Within equities, one can consider either mutual funds or direct equities. In both cases, you will need to decide which segment you want to target like Large, Mid or Small caps as mutual funds and stocks are classified accordingly. Below are typical features of all three which can help you choose one of them or many of them. The returns quoted are from mutual funds and not individual stocks.
- Large Caps: Expect returns to the tunes of 10-12% per year. Relatively stable but can drop by -20% as well. Holding period, atleast 5 years.
- Mid Caps: Returns to the tunes of 12-16% per year. Can swing up & down. In the past they have fallen by -30% as well. Holding period, atleast 7 years.
- Small Caps: Returns around 14-20%. Can go down by -50% or more as well. Holding period atleast 7 years.
3. Be Sticky
Once you choose your investment option which can be a mix of few investment vehicles, you have to stick to it for atleast a decade. This is the most tricky part where most investors falter. Since returns are wavy in natures and performance can be up & down, investor has to guide his “investment ship” firmly on the course. Please do not try to switch your investment option by chasing the best performing segment as they keep rotating. If one had chased small caps in 2017 without any thought, they must be facing losses at the moment and just went tide seems to be turning for small caps, they might have shifted to large caps due to last year performance. This is recipe of investment disaster as investor will always remain behind the curve. Instead during distressed time, an investor should load more from his chosen segment. For example, one could have loaded large caps in 2016/17 when they were cheaper. In the same manner, one could load up mid and small cap now as they are cheaper. At the same time, an investor should have enough heart to sell his bad investments. Never throw good money after bad money. If a company had gone bankrupt or there is no hope, you must exit such investments to repair your portfolio.
4. Be Selective in Listening
Last and also very important is to be selective in taking advise or jumping on conclusions. With internet, there is overloading of information which can mess up your mind, midway through your investments. You need to trust just a few selected advisers / well wishers / yourself. This is very important because in life you will meet many bankers, brokers, news-channels who have their vested interest and will urge you to change your investment approach. Your adviser should be independent and must charge a fee for his advice. All free advices have hidden commissions loaded in it one way or the other. There are no free lunches.
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We hope after reading this article, your mind is much clearer and you can take investment decisions more confidently. Feel free to share using sharing buttons at the bottom of this page.