Commentary | Portfolio Yoga

Trump Inferno

Markets have been on a slide in recent days, when the S&P 500 closed in negative on Friday, it was for the 9th consecutive day though this has been one of the few times when even after such a large number of negative days, the Index itself has fallen just around 3.1% making it one of the slowest grind one has seen in history.

Indian Markets haven’t done too badly though they too are on a steady decline since early September and are now down 6% from the peak. DII’s have been active buyers beating FII investments for the months of September and October. Last time we saw 2 or more consecutive months of DII’s buying more than FII’s was way back in November 2015 to February 2016.

Every fund manager will tell you that it makes sense to buy every dip since markets have always bounced back. The question that gets unanswered is, how deep can this dip be and what point the odds of getting in makes sense vs just staying put.

Some dips are small and cozy, others dangerous and beautiful (for those who were waiting for it) and only after it has ended do we really understand the nature of the move.

Here is a pictorial view of all draw-downs from the 52 week highs.

While the 1992 and 2008 falls occupy the investor mind space, as the chart showcases, 10% falls are normal and we have had multiple falls of 20% or more.

Earthquakes are measured in Richter scale where each level is 10 times stronger than the previous one. While we have no such scale, data suggests that there is a huge difference when Index falls 10% vs 20%. Small and Mid Caps are the worst affected.

Look at the Total Market Chart here for instance. While in the above chart the 2000 fall was one of the many, stocks fell like a ton of bricks back then. Do note that since there is a survivor bias in the database pre-2005, it misses many a stock that never recovered from the deep falls it saw.

So, what am I trying to say?

While falls are normal and markets shall recover, not every fall is the same and not every stock will recover. Choose your instruments wisely and calmly.

Other than the recent instance where markets got the Brexit vote wrong, historical evidence suggests that market knows better and the trend is generally established correctly going into such crucial votes.

Take for instance our own elections of 2004 and 2009. In 2004, it was given that NDA was and will win hands down. But way before the counting happened, markets action was anything but bullish as it was well and truly into a decline. In fact, the bottom happened after the results broke out showing NDA on the way out.

While I have no answer how the market anticipates, its amazing how the trend was in place before the September 2001 attacks or the Kobe Earthquake (Baring’s Bank demise was due to that incident).

In June, I wrote whether this was the start of a bull market when Nifty was around 8200 level. Currently we still stay above that level and given that most indicators have a lag, it will be pretty late by the time we know that we are well into a bear phase.

Reactions in bull market are normal, but some reactions push the same into bear territory. Will this reaction follow similar lines? I have no clue though for now data does suggest that its still very much in a bull phase.

Markets aren’t cheap though as usual they aren’t too expensive either and its in these phases that there is ample confusion on what to do next. Should you buy the dip or wait for a further fall and what if the big fall doesn’t come true?

Historically, data suggests that markets have risen under both Republican President as it has under a Democrat guy. So, regardless of whether Donald wins the race or Hillary manages to hold on to her lead (as every poll still suggests), markets aren’t going to go to dogs.

But assuming we do have a huge reaction, the question is, are you ready? Both in terms of strategy on what you will do and tactic of how you shall do.

Results will start coming out I am told by the time Indian opens on 9th November which means that you have 2 days to get ready and act if opportunity provides one with a window.

Fooling some of the people, all of the time

The single biggest reason you are given as to why you should invest in stock markets using a Mutual Fund and not via a Exchange Traded Fund or a Index Fund is proved by showcasing long term returns of few select funds that have over the last decade beaten the Index returns handily.

In past posts I have reflected on why this is not really the ideal comparison given the Survivor bias such lists tend to have yet the fact remains that few funds have really performed well over the long term. No two ways about it.

Here is a table detailing the percentage of funds that have beaten Goldman Sachs Nifty ETS Fund returns.

On the face of it, it seems that on the short term, funds really do deliver the results with more than 90% handily beating the benchmark ETF we have chosen for this exercise.

But this seems to keep dripping down as more time passes by though theoretically given the Survivor bias as well as the understanding that Alpha is generated by focusing on the long term growth, we should have actually seen that rising.

So, what is happening out here?

On the short term, there is a very high possibility of luck being mistaken for skill. Extreme short term returns aren’t hence the best viable way to evaluate a investment, especially one during a bull market where you can get away with higher risk (and hence the higher return) without anyone being wiser.

For instance, while on a 1 year basis, Goldman Sachs Nifty ETS Fund has given a return of 6.82%, over the same period, a Index fund tracking the Sensex had a range which went from a low of 2.85% by LIC MF Index-Sensex Plan to a high of 7.34% by HDFC Index Fund – Sensex Plus Plan. With both Indices seen as benchmark, and both Sensex plans theoretically following the same allocation pattern, one wonder what gives for such a large difference in returns. While the range wasn’t as big in Nifty Index funds, it still stretched from 5.19% (IDBI Index Nifty Fund) to a high of 7.96% (Edelweiss Exchange Traded Scheme-Nifty 50).

In his book, The Success Equation, Michael Mauboussin writing has showcased the importance of Luck and how tough it is to differentiate that from skill in the short term though on the long term, skill clearly distances itself from results which are owed primary to the significance of luck.

There are two ways of investing in funds. One is by way of lumpsum and another is by way of Dollar cost Averaging (commonly known as SIP). Both have their own advantages / disadvantages depending mostly on when the investment was done and the length of time it was held.

A few years ago, Vanguard had done a extensive test on whether a investor should go with a DCA approach or a Lumpsum. You can download the study from this link. In recent times, a investor in mutual funds has been bombarded with information on why SIP is the way to save.

But, how do you choose among the hundreds of funds that are on offer? When Index funds themselves have such a wide range of returns, the range expands more as you start comparing actively traded funds. And here comes the financial advisor who says that since you really cannot expend the kind of energy needed and understand the intricacies of those funds, we will (for a fee that is duly debited from you) help you pick the right fund.

Today, I noticed that Quantum Long Term Equity fund has reached the summit in terms of 10 year returns beating every other fund. But when it comes to AUM, its way lower since they were the first and till date the only fund that doesn’t utilize the services of a distributor. But I am digressing.

To help you pick the right fund, most distributors have what they would say as funds they believe is right for you. Yesterday, I was going through the Select funds of a major online distributor and was surprised at the number of funds that were added and removed in the short time frame I looked at.

When it comes to Systematic Investment Plans, the question is how long you should keep investing. Most application forms these days have the option of investing for eternity (theoretically) since the belief is that if you keep investing over a long period of time, the return you get is substantially on a higher level.

But while investing regularly for long is a correct thought process, the returns are dependent on the choice of instrument.

In the table, you can see that funds are constantly getting churned all the time. While the advisor does point out that removal doesn’t warrant a exit, it still is suggesting that maybe further investing in such funds are sub optimal in nature.

When people flash about how 10 year SIP would have given so high a XIRR return (a number that most people confuse for CAGR but isn’t – read by previous post), how do you do that if large well known distributors keep shuffling funds based on short term returns (based on my understanding of what they looked at before removing).

If you started out in a SIP today in a fund that is part of the list but subsequently gets dropped, do you continue to invest in a scheme that may be sub-optimal. What if 10 / 15 years hence it showed that if you had just continued to invest, you would have beaten 80% of other funds and what if 10 / 15 years later you learnt that because you kept investing in bad fund, the returns are sub optimal?

In other words, Question leads to more Questions and further more Questions without there being a clear cut answer. If you are saving for your daughter’s education which maybe 20 / 25 years, do you really know which fund you should seek out to help you in mobilizing the said amount?

I don’t exactly remember when, but on the short term, Quantum fund was under performing due to its high cash holding. It was also the time when it got kicked out of Mint 50 (a set of best funds that you can select from). But given the funds recent performance as well as long term, how much of a cost would that have meant for a investor who was blindly following what was advised?

The biggest reason I like ETF’s is that after accounting for Expense Ratio and Tracking error, I know for sure how much I can get depending on the choice of instrument / index I have chosen. That is way tougher with active funds (Quantum included) since it requires a reading of the mind of the fund manager and what he believes is the way forward.

These days, I find a lot of funds coming out with what they say are their core philosophies. If you were to understand and accept that, it makes a lot more sense to just stay with them (and hope that they stick to their words) then keep switching in and out in an attempt to find the best funds.

But if you were to look at persistence of returns, as time passes by, I feel that you will find a way smaller list of funds that can persistently deliver. The pool of actual alpha generators is anyway way smaller than what we assume it to be based on short term out performances in a bull market.

Investing and Returns

A couple of days ago, writing in The Guardian, Tim Harford questioned and I quote

“Is our reliance on automation dangerously diminishing our skills?”

These days, we depend on Technology a lot and given our beliefs that a computer cannot go wrong, we accept the results without questioning the Math’s or the logic behind the answer.

Regardless of whether we are strong in the field of mathematics or not, most of us are able to do some simple calculation without the need to think too deeply on the subject. For instance, if I say that give I shall give you 12% on your money, you can easily calculate that if you gave me 1200 (we would generally use 100 / 1000, but using 1200 since it avoids decimals later), you will get 1344 at the end of one year (assuming that 12% is for a year). For ease, let’s refer to this as Lump sum.

But what if I told you that I shall take your money in installments and enable you to earn a XIRR return of 22.75%, can you calculate (even after taking the assistance of a computer) what your real returns will be? For ease, let’s refer to this as SIP.

Here is the thing. In both cases, you gave me 1200 Rupees and received 1344 at the end. But when it comes to knowing how much you earned, the difference between 12% and 22.75% is huge if not staggering.

But how do you end up getting that 22.75% and nope, it’s incorrect though it would be wildly inaccurate to compare a XIRR return with a CAGR return (or compare a returns generated by SIP over returns generated by lump sum investing).

We are generally used to relative comparison whether we use numbers or otherwise. When I say A is tall, it’s always relative to B or C who maybe shorter than A. But if D is taller than A, does that mean A is not tall?

Microsoft on its website describes XIRR as such;

Returns the internal rate of return for a schedule of cash flows that is not necessarily periodic. To calculate the internal rate of return for a series of periodic cash flows, use the IRR function.

In other words, when you have a series of fund flow that may or may not be periodic (SIP is generally periodic), this is a tool to calculate the Internal rate of Return.

Let’s return to our example I described above. If I take 1200 in lump sum from you and give you 1344 after one year, for a period of one year, you had no access to 1200.

On the other hand, if I asked you to give me 100 Rupees every month and end of the year retuned 1344, you would have earned an XIRR return of 22.75%. On the other hand, if I give you back 1277, I would have given you a XIRR return of 12%. Notice the difference?

The reason for that difference lies in the fact that after month 1, while in lump sum you have no money left in your hand, in the case of SIP, you still have 1100 that is yet to be given to me. At end of second month, you still owe me 1000 that you will give over the next 10 months. This money that you have has a value and the return using XIRR adjusts for that (theoretically speaking).

So, why am I talking about XIRR and CAGR returns? In recent times, Mutual fund houses and distributors have given a huge push to sell retail investors the idea of investing in Mutual Funds using Systematic Investment Plan. In itself, Systematic Investing is what we should do – whether its pushed or not. But when the push happens with the kind of returns as projected in the pic below, its setting up for disappointment

To showcase returns, most use XIRR as the tool to compare different schemes. So long, so good. But the problem is more on our side than the seller. Because of our unwillingness to use System 2 (Thinking, fast and slow by Daniel Kahneman), it’s easy to confuse XIRR with actual returns that we get. But think deeply and you shall see that what you see is not what you get.

When we invest in a Bank Recurring Deposit, our expectations are fixed. We invest X rupees for n months and at the end of the period we get Z. When we take a loan for a House or a Car, we know that we need to make a payment of X Rupees for n years and then the asset is ours (full and clear).

But when it comes to investing, especially investing in markets, the expectations and reality we face could be vastly different. Assume for instance that you started off a SIP in the month of May 2003 (you couldn’t have picked the bottom better than that). You keep investing a fixed sum of money without fail – you are prepared to wait for the long term.

The correct way to depict returns would be as per pic which shows how much the investment of 72000 would have turned into (ignore last column which again is XIRR return). Picture courtesy (Pic-1 https://www.advisorkhoj.com, Pic-2 http://www.finvin.in/)

But then you get hit by the 2008 financial crisis. At the bottom with job loss being a worry, let’s assume you decided to take a look at what your investments have done. While markets have fallen, they are still 200% above where you started to invest. Your investments should have done well you assume and open up your account statement.

While you had invested for 70 months (let’s assume 10K per month) an amount of 700,000, your current value would be 816,887. Profit, yes but not something you would have expected. This again is due to the fallacy of comparing one sort of returns with another.

When we receive our final number, we quickly will use a calculator to see the return and would be horrified to see it gave a CAGR return of just around 2.65%. While the comparison is wrong (Apples to Oranges), the reason we fall upon it is because we understand the simplicity of it.

For the same values, if you use XIRR returns, you shall get the return as being 5.37% – low, but not as low as the CAGR we came up with.

While both are different, do note that either way, returns are way normal than what you may have expected. When mutual funds complain that a lot of investors stopped in 2008 / 09, the reason would be about their expectations not matching reality.

Mutual fund SIP returns are dependent on multiple factors (including market), but the three key things are

How long you are investing
When did you start (Starting date bias)
When did you end

In the above example, returns would have been wildly different if you had started investing a few months later or stopped investing a few months later.

If you had started your investment say in Feb 2004 (one year later) and stopped in Feb 2009, your returns would be XIRR of 0.71% while in real terms, your 6,10,000 investment would have given you back 6,20,961.00

On the other hand, if you had stopped investing a year later (Feb 2010), your returns would be 19.71% while in real terms, your investment of 8,20,000 would be 16,01,760. A difference that is too big to ignore given the small change in time frames we tested with.

It’s easy for most of us to fall prey to availability bias (among our many other faults), but do remember that the final returns are not measured in either CAGR or XIRR but in what you finally receive in exchange for taking the risk.

Your expectations should be built on that reality alone since that is what we can finally compare and contrast easily. This is further and better explained by Utility of money. That is a big subject in itself, so shall leave you with this simple explanation taken from the site http://www.behind-the-enemy-lines.com/

If you want to read more about utility of money and its applications to portfolio management, insurance, and analysis of other cases, take a look at this book chapter.

PostScript: Both Pic-1 and Pic-2 contain similar info. Apologies for the confusion. Point I was trying to make is that you focus on the End Value vs comparing the % returns with other investment avenues you may have had the opportunity to invest in.

SIP, Expectations and Reality

Indian’s have generally been Risk Averse and that is seen in the percentage of assets an average household has invested in markets (Direct or Indirect). Real Estate on the other hand has had huge amount of backing given the rally we saw in the last decade. But with Real Estate prices shooting for the moon and one which is affordable by a very small segment of population, investors are now turning towards equity in an attempt to get returns that are better than Inflation.

Mutual Funds in India has been as old as the hills with plenty of funds being launched by Unit Trust of India since the 1960’s. While the Asset under Management has been growing in time, given the growth in economy, it was still a lagger.

While Mutual Funds have all sorts of schemes, for the retail investor, most funds recommend Equity since only Equity has ability to provide for positive returns after adjusting for Inflation. And then there is also the small thing about being able to extract a higher fee from equity than from Debt.

In recent times, we have witnessed funds going all out in attempting to push investors into embracing equity investing through SIP’s. In this blog itself, I have written enough on the Pro’s and Con’s, so I will stay away from the same.

Today, lets talk about the term Equity Risk Premium. Investopedia defines it as under;

Equity risk premium, also referred to as simply equity premium, is the excess return that investing in the stock market provides over a risk-free rate, such as the return from government treasury bonds. This excess return compensates investors for taking on the relatively higher risk of equity investing.

Its effect is better seen if you were to compare Nifty Total Returns (the benchmark I like to use) vs a Liquid Fund (SBI Magnum Insta Cash Fund).

As you can see, its really one sided with Nifty Total Returns beating the Returns of the Liquid fund hands down. But that is the reward. What about Risk?

Liquid fund has no draw-down. Every day is a high day and you cannot get a better picture than by seeing the chart of the fund. In other words, at no point of time is the value of your investment lower than what you have invested.

Equity on the other hand provides no such guarantees. As any investor who invested in late 2007 can tell you, at the depths, you wonder if you have lost everything you have invested even though you may have invested in a Index rather than individual stocks (where such risk definitely exist)

At multiple points in time, you had 40% or more of falls from peaks and this is Risk that you, the Investor is willing to carry for the +ve returns you hope to get.

But how much extra do you really get? To get to that answer, I used Nifty Total Returns and subtracted the returns of the Liquid Fund. Results are as here under;

(Click on the table to expand if you cannot view data for all 17 years).

What does the above table tell you, especially the row that I have color formatted (Median Returns)? Do note that the data is not adjusted for Inflation.

SIP is a excellent way to save money, but is it the best way to invest in markets given the near uniform distribution of returns? Good Friend, Kora Reddy the other day tweeted (read from last to first),

The data in the table I presented above is more of a synthesis of what Kora tried to put up.

If you invest in a SIP and can do so for more than 10 years, you really start to see the benefits start to show up.

But once again, there is the question of whether the fund you choose to invest will be able to beat the Index over the next 10 years. If you were to look at data that is publicly available, the percentage of funds that have beaten Index is very high at the 10 year mark (due to Survivor bias effect) and keeps coming down year upon year.

These days, most SIP’s have option to invest for perpetuity and hence if you can hold onto your behavior when markets crack next time around (and hold onto your Job as well) and if you have chosen the right fund, you may be happy with what you have achieved once markets come back (as has happened ‘n’ number of times in the past).

But money has a utility value and if you need that money when markets is not at its best (its all correlated – market falls / job loss / health issues – everything happens at the worst possible time), you know whom to blame, or do you??

Predictions, Probability and Position Sizing

Most of us know that Astrology is bunkum and yet that doesn’t stop us from reading what the astrology section of the Sunday newspaper. Reading that does no harm, Right. After all, its more of just keeping ourselves aware or more of a time pass in nature.

Prediction in markets happen regularly and here there are two types of prediction. The Implicit kind and the Explicit kind. Let me explain each with a example.

We trend followers are staunch believers in fact that future cannot be predicted and we can only rely on the past and take signals based on what we believe the trend is. But the moment we make a trade, we are Implicitly predicting that price will move in the direction our trade dictates. If it does, we have caught the right trend and we make money, if it doesn’t, we call it a Whipsaw, scratch out the trade and await a fresh signal for the next trade.

On the Explicit side are strategies such as Elliot which not only spell out where the markets should / shall go but also the time frame within which it will reach such a target. Take for instance this prediction by Mark Galasiewski, a very well know Analyst from Elliott Wave International

On April 13, 2009 speaking with CNBC TV18, he made a very famous predicition

See Sensex at 100,000 in 15 yrs: Elliott Wave International

The prediction contains two elements required to make a trade. A target price and the target time. Given these two parameters and assuming you have confidence in the said analyst, the next question would be, “How much to Bet”

On the day, he made that call, Sensex was close to 11,000 mark and hence this prediction if it were to come true would mean a CAGR return of 15.85%. Here is the thing, 15.85% isn’t extraordinary returns.

CAGR Returns since Inception of Nifty Bees (then managed by Benchmark and now by Goldman Sachs) is 16.62% (as of Aug 2016). While we don’t know whether the next 15 years will provide similar returns, we at the very least have a number we can work with.

In April 2010, Chris Roberts of Mizuho Securities Asia Limited made a similar prediction, this time we have a chart providing us a better guideline as well

But lets go back to 2009. Markets are down but definitely not out and you believe in the said analyst prophecy. So, what next – Buy Nifty / Sensex would be the way forward – but the bigger question is, how much to bet. Should you bet 10 / 20 / 30% of your existing portfolio or go all out and bet 100% or go still further, Sell your House and invest everything?

The reason why people are so attracted by Real Estate is due to not the percentage of returns (which has been good till very recent times) but the amount that one sees as the outcome. But unlike stocks, in real estate, the minimum required is way higher.

When people invest into houses / land, most of the time they are betting way more than 100% of their networth (since most go with a loan, its actually multiple times their networth). Would you do that with Sensex or Nifty (lets not take stocks since we all know that not all stocks are the same) and if not, why not?

The biggest fear is the fear of not knowing what the future holds, especially decades from now. While the same risk exists in Real Estate, we comfort ourselves saying that even if the worst happens, I still will be able to hold onto the asset.

Its a fact that most world markets have at some point or other seen a 85% draw-down from peaks. While our data (public) exists only from 1979 and has a max draw-down of around 50% thrice and in those times, even the guy who has strongest belief may find it tough to hold onto his investments let alone add.

A fun fact (Fun b/c I am not sure about the source of the data): Indian markets fell 73% from their peaks of 1920 and recovered only by 1945 (25 years).

Lets cut back to our original problem. If we have a forecast, how do you action the same? This question was what engrossed me in a twitter match when I replied to a particular prediction by a Analyst who is the head of Research at a major brokerage firm

There were essentially two questions that I posted.

What is the probability that we shall reach 9410 by Diwali
Based on that probability, what should be the position size of the same.

The analyst who made the above prediction came back with the following reply

“Isn’t position sizing matter of capital allocation and risk appetite rather than probability of success?”

In my opinion, probability of success is what should drive capital allocation and not the other way round. In the above example, I based on distribution of returns calculated that at best there was a 11% probability of 9410 coming into play in the next month. Using VIX, Vasishta (@Uptickr) gave a even lower probability of 5%.

Given the above numbers, what should be your bet size. Do note that since the original forecast was made, the markets are down 4% (target was 5.5% approx) making the original prediction look like a one to one on a risk reward basis

So, why is position sizing important? As @ReformedBroker tweeted the other day,

Replace the word hedge fund manager and place yourself there. What do you spend the maximum time upon?

Selecting the right securities are betting big when you think you have found the one that will provide the returns you think you deserve.

Switch on the Idiot Box and all you can see is analyst upon analyst predicting either where Index would be n days from now or which security should one buy.

Probability of Returns is always two sided. One way to calculate the probability of returns is to use Chebyshev’s Inequality, but that will still give you the probability of returns and not provide you with a way to determine how much position size should be taken based upon the historical reliability of your signal.

The simplest position sizing when you are dealing with a portfolio of stocks is to have uniform capital allocated to each and every pick.

But what if you are trading a single ticker like Nifty or Bank Nifty and come across predictions such as the one above? How do you decide how many contracts to buy for every Signal?

With Deepawali coming up, every Television channel will be pulling up every analyst they can to provide them with a view on the coming year and a list of stocks that investors should buy for the year ahead. So, should you go ahead and buy those stocks and if so, once again, how much should you be betting?

As Investors and Traders, we love predictions and if you are on Television, what better way to get noticed than make either a very dire forecast (like Marc Faber does every year) or make staggering bullish forecasts that once again make news.

While I have no idea if anyone has created a data set of predictions by brokerage houses and the error ratio’s, out in United States, Salil Mehta writing his blog Statistical Ideas, provided a humongous amount of data and aptly named the post as “Strategists: full of bull“. If some one were to do a similar anlaysis in India, I don’t think one would find any major difference in the hit rate of such predictions.

The key to position sizing in any asset class / stock / index / sector is conviction. Think of a experiment you can try out at home. Announce to your family members that you have 20 Lakhs with you and will invest that into buying a 1 Crore property (by taking a loan 4x your investment). If you are part of a normal Indian family, you should receive more queries on property than query on whether it makes sense financially taking such a big loan.

Now, what if a few days later say that you have dropped the idea of buying the home but will invest the same into market (remember, no loans, only investing what you already have saved). The reactions now will be way different and more or less you will be taken as a gambler who is out to destroy his savings.

The difference comes from the conviction we folk have in Real Estate / Gold vs investing in Equity. Conviction cannot be build while having faulty premises that fail at critical times.

Postscript: Thinking deeply, felt that unfair to name a single individual just because I was engrossed in a debate with him while the rest of the guys get a free pass. I have hence removed the tweet. My Apologies.

Fire your Financial Advisor?

In today’s Mint, Monika Halan has a post titled “When to fire your financial adviser“. While I am sure she knows way better than me when it comes to advisers, I felt that she had used a large brush without providing contexts when its right and when its wrong. So, here I go as usual with my thoughts;

MH: An adviser who gives you the average without separating out the asset classes when disclosing returns needs to be questioned.

Me: Assuming your have your entire networth here, its actually how much your networth is growing. Now, if we start splitting, why stop with Debt vs Equity since not all Debt or all Equity are the same. The difference in returns between investing in a large cap equity fund vs a Thematic equtiy fund can be huge. But that difference arises due to one being of a much lower risk than another. If Equity returns are bumped up due to a couple of them, is your advisor a Genius or one who is taking bigger risks?

Coming to Debt, are all Debt funds the same? Of course, not but will you understand what risk he is taking or what time frame he is looking at just by concentrating on the returns he has generated?

MH: If you have more than a total of 10 funds—across all categories—you need to question your adviser.

Me: To me, this answer once again misses the context. Its not about how many funds you are having that is the problem. The problem will be in terms of how correlated they are and how much portfolio overlap you are seeing. A large number of CTA’s trade as many as 100+ non correlated assets at any point of time. If you are having multiple funds but very little correlation between them, you are actually pretty well diversified. Of course, this could also mean lower returns, but volatility will be lower too.

MH: The guy is churning you; maybe to win a junket his fund house is offering.

Me: This is the risk of going to some one who you think offers his services for Free but makes money in the back-end. Fee based advisors have on the other hand no such conflict – they receive a fixed amount and hence are less susceptible to making you churn your investments.

So, how do we know whether my advisor is doing the job or is it time to fire him?

The biggest issue that is not addressed in the article is what benchmark is the one you should aim for. In my opinion, if you are a risk averse person but one who wants a bit of higher returns for his investments, you should ideally got for a split of 40 : 60 in favor of Debt to a max of 60 : 40 in favor of Equities.

It would have been lovely if we had a ETF similar to Vanguard Total Stock Market ETF, but given that we don’t have that, our best bet will be to use the GS Nifty Bees as the Equity component benchmark and something similar to the LIC MF G-Sec Long Term Exchange Traded Fund as our Debt fund benchmark.

Now, lets get back to our starting point. Assume you invested a year ago. Download data for the ETF’s you have selected – the debt fund ETF above may not have that much data in which case you will have to use the Index it tracks.

Once done, assume your investment was made in the ratio you are comfortable with or are invested in. Based on present value, does you returns match or is higher than this? If Yes, your advisor has generated better returns which is good.

But Rewards are one side of the coin – on the other side you have Risk. So, using the same data you now need to calculate the volatility of your investment and compare (not sure you can easily get such data from your advisor, but you pay him and he needs to provide you with it at the minimum). Here, our aim is to see if we are having a lower volatility. A high volatility means that you are taking a much higher risk to generate the said returns – seems acceptable in good times, its only in bad times that we wonder what hit us. Yes, doing such Analysis is tough, but hey, its your money and the least you can do is try and understand how its doing once in a while.

Either way, understanding what your financial advisor is bringing to the table is the key in deciding whether to continue with him or fire him. Nothing comes for free but not all costs are acceptable.

Where is your Edge

A friend of mine has a shop selling something which in theory has no moat whatsoever. If you wish, you could easily put up something right next to him and start doing business. Margins are good which means that there is pretty high attraction to getting into his business. Where there were just 2 a few years ago, I now count 6 within walking distance from his shop.

For now, everyone seems to be happy and have enough business, but as my friend knows, the business runs in cycles and there are times when he has hardly any sales. But he has a edge that the others don’t. While others need to make enough to at least cover their rents (and the area is notorious for its sky high rents), he owns his shop making it much easier for him to overcome those dull times.

Mutual Fund and Distributors are these days spending money and time trying to convince you that investing in a Mutual Fund via SIP is the best way to save for your future goals. Theoretically they are right, its much better to save more systematically each month as it all adds up over time.

But when it comes to Mutual Funds, there are literally hundreds of choices out there. How do you choose the one or the select few that you think will help you in reaching those goals.

Stock Advisory is as old as the Stock Market itself – why bother to research on your own when you can just pay a small fee and be provided the stock to buy / sell rather than you having to wade through hundreds and thousands of stocks.

And then there is Insurance. If you were to carefully check out advertisements of Insurance Policies, you would have heard “Insurance is the subject matter of solicitation” but have you thought about what it really means? . Not many customers bother which means sellers have a field day.

What is common among sellers of all the above products?

They all profess that they can help you reach your goals which generally is about making X amount of money by Y time. Some are qualified, most are not but as long as they have the gift of gab and have the ability to make things up as they go, how many will really question things they claim to be true but which aren’t.

When you go out to buy a product, lets take a Cell Phone for instance, we do plenty of research before we even hit the showroom. We ask Friends about the one they use, we browse the internet trying to find out more details and finally figure out the brand which we want to buy.

Having done all that, its still easy to fall to the talk of a sales guy who tells you how great this new Cell Phone is is and how much its been selling in the market (even though before this day you would have barely heard its name). A few years ago, me and my friend went out after doing research to buy a Samsung phone but ended up buying a Karbonn since we fell to the talk of the sales guy who in all probability would get more commission to sell a phone like Karbonn than selling Samsung.

The phone wasn’t as great as it was advertised and after a couple of years using it, my friend junked it for a better one. But while he was unhappy with the phone, he seldom felt the same about the seller despite the fact that the sales guy had the Edge in terms of being more knowledgeable than we were.

The reason we get misled in finance though comes down to our aversion to learn even the basic things about savings and how the various choices pan out against each other.

The web is filled with information that you seek but you need to search it out for it to be of any benefit. While most of us are happy to slog for 8 hours, when it comes to learning / understanding about finance, we are just too tired and want some one else to make the decisions for us.

That some one needs a motivation – it maybe in terms of a trailing commission as in case of Mutual Funds and Insurance or a fixed fee per month in case of stock advisers or a one off payment in cases such as the Real Estate broker who helps you find a house to invest your money.

When it comes to investing in Mutual Funds, how many times have you heard your adviser speak about Quantum Mutual Fund – a fund that has outshone its peers in recent times and stands among the best even when comparing with others on 5 year returns. How many times have you heard your Insurance agent talk about Insurance not being a Investment and hence you should look for Term plans vs Moneyback Plans or ULIP for instance. How many bank employees have advised you that if you were in the highest bracket when it comes to Tax, you maybe better off with a lot of other debt based assets that yield more after tax than a simple Fixed Deposit.

You don’t hear any of the stuff because saying so would mean cutting off their own money tree and who in the right mind would want to do that. Advisory is supposed to be a Fiduciary duty and yet for most, its what makes their dough that is the biggest concern, not what is right for you.

To say that you need to save more is easy, To say that you can save more by investing better is way tougher because the future is uncertain and non one has a clue other than to look at history and hope that history repeats itself.

If you are reading this, I would guess that you already have a Edge. You know what works for you and what doesn’t and aren’t swayed by glossy advertisements about returns that seem out of the world. You know about the various biases you can fall into them without even our knowing.

But then you are part of the minority (and this applies equally to any country you can think of). The reason for starting this site were many and one of them was to help provide perspectives to investors and traders alike. While I have no clue whether my posts here or my rants on twitter are doing anything, the way it has rattled some tip sellers I hope means that I have hit some right spots.

So, back to the Question. What is your Edge when it comes to Investing? If you can answer that (and hopefully is data backed), you have ARRIVED.

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