Savings and Investment

From a young age, most of us learn about savings from both what we study in school (the Story of the Ant and the Grasshopper being one classic) as well from our parents who imbibe the importance to save a penny for the rainy day. Savings in other words is the amount of money we are able to keep away from using in the hope of it coming to use for a rainy day or fulfilling our goals / dreams / ambitions.

While we understand savings, investment is quite another aspect that is rarely understood in full. Before the real estate boomed and the stock market gained market share, investing was all about buying National Saving Certificate, taking that Fixed Deposit and if you had a relative who was a LIC agent, buying that money back policy that was peddled as safe investing for you and your family.

Gold and Real Estate were not investments in the real sense of getting a absolute return from it but requirements that got fulfilled. A house assured one of a roof over ones head and with regard to Gold, well, Gold is always Good, ain’t it? 😉

These days, choices have grown in scale and size to the extent that Post Office Monthly Income Plan is no longer something that is even known to the younger generation. But more choices doesn’t really mean better since its easy to confuse the relationship between risk / return and our time frame.

Friend Mahesh has written a interesting blog post which among other things discusses using SIP as a tool for savings. While not a believer in SIP, he makes all the right points but misses the most important one – which is your ability to withstand the pain of losses.

When I was in school, my Aunt opened a Recurring Deposit in my name into which every month a princely sum of Ten Rupees was invested. Every month I used to go to the Bank to make the deposit and update my Account which reflected the new balance.

For some one who spent less than 5 Rupees a month, the happiness of seeing a steadily appreciating balance was something that couldn’t and cannot be easily explained. Now lets change the equation a bit and assume that instead of investing in a RD I was investing in a Mutual Fund using Systematic Investment Plan.

In months when the market was good (read as going up), I would be excited to see my investment appreciate in value and would be more than happy to continue to invest. But what if I started off investing just months before the markets were peaking?

While I would have enjoyed the strong growth that my initial capital would have achieved, as the markets took a turn and the value of my investments declined steadily at first and rapidly later, how would my psychology work in terms of continuing to invest.

Lets make another assumption here and say that I also have a adviser who says that this is normal cycle of market and if I continued to make the investments, I would see better days ahead – a kind of Light at the End of the Tunnel. How long do you think that I would have continued to invest even as markets dropped from where I started and every fresh investment I was making was getting eroded as well.

Too many advisers say that while investors are happy to pay large EMI’s for their housing loans, they aren’t prepared to make similar investment in markets. But are the two one and the same when it comes to how we perceive and how we act based on our beliefs?

If you bought a apartment and pay a EMI, you are effectively paying off a loan for a asset that you not only see each and every day but actually enjoy using the same. When you are investing in a Mutual Fund, you are basically betting on historical data and believing that the future will be as good if not better than the past.

Since data for Indian markets is pretty short, I used data for US Markets and provided two instances where markets did literally nothing for years at a stretch.

Two examples (Chart) from Dow. pic.twitter.com/g7QypdXJs9

— Prashanth (@Prashanth_Krish) February 2, 2016

Markets move in cycles of strong bull and bear markets and everything in between. When you buy when markets are over valued, the probability is very high that you get a very bad experience in terms of returns and vice versa.

In a previous blog post of mine, I outlined how huge funds had flown into Mid and Small cap funds which resulted in the Price Earnings Ratio of the Mid Cap Index moving higher than what was seen even in 2008. With the markets now retracing its steps and results of companies not exactly coming the way markets and analysts assumed it would be, how long do you think investors are willing to bear the pain of continuing to invest even as the returns are close to flat or worse negative?

Investors constantly confuse the difference between Relative Returns and Absolute Returns. In markets which are rising, they look for Relative Returns while in falling markets they want Absolute Returns. Most advisers just set them up for failure by not advising them correctly and distinguishing the same.

In last 24 months, 88% of total money (net) raised has flown to Mid and Multi Cap funds. Mutual funds did their work by launching new funds to take advantage of the shift as well. With mid and small now starting to correct, how long do you think investors will be willing to wait patiently waiting even as markets continue to drop.

Investors around the world suffer from Recency Bias. Even accomplished fund managers are unable to stop their investors from running away after just a year or two of bad returns (Latest Example: Einhorn) and Investors in Hedge Funds generally have a better understanding of market even as they act similar to the lay man on the street.

Mutual funds (Equity) have the limitation of having to be invested (70% IIRC) all the time which means when the cycle turns, they generally end up getting hit fairly big. What hurts investors more is the lack of communication when the chips are down as to what the reasons are and how they perceive the future shall be. The only communication is to stick with the investment as light will finally emerge at the end of the tunnel.

Some time back, I had done a test on the Dow as to how long it would require to be 100% sure that Sipping will provide positive returns (no matter when you entered). The results (pic below) surprised me quite a bit. Hope it provides you a different perspective than the one that is generally preached as the holy gossip