Creating wealth: Tips from three investment gurus

In this article, we discuss the general investor behaviour and how some of the ideas by investment gurus can help us avoid common investment mistakes.

Investing is all about making the right decisions but at times we do get confused by the sheer fluctuations in the market place. We thumbed through the guiding principles followed by international investment gurus and we have picked John C Bogle, Peter Lynch and Warren Buffett.

We feel their insights do hold relevance to the quintessential Indian investor and hence, can help you tide over tight spots.

Disclaimer: This article is for information purpose only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products /investment products mentioned in this article or an attempt to influence the opinion or behavior of the investors /recipients.

Any use of the information /any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.

Complex choices: Start with index funds

The foremost challenge faced by most of us is to pick the right investment product. Also, the presence of a wide range of products makes the choice even more difficult.

CII-KPMG conducted a survey of top ten cities in the country in 2009 to understand customer preferences. One of the critical findings of the survey is that, "Availability of a large number of mutual funds schemes makes investment decision complex and difficult".

John C Bogle, founder of the Vanguard group, suggests index funds for investors who seek high returns from broad market sectors (source: Common Sense On Mutual Funds: New Imperatives For The Intelligent Investor).

For example, Sensex represents the large, well-established, top 30 stocks across sectors in terms of market capitalisation. Similarly, Nifty Midcap 50 reflects the momentum in the mid-cap segment of the market.

Index funds follow a particular benchmark index and track the stocks which are present in that index. The portfolio for an index fund will not often undergo changes unlike an actively managed fund. Hence, the expenses for this fund are generally lower than other equity category funds.

The shortcoming of an index fund is that most of the index stocks may not be cheaply available. For a start, investors can consider investing for the long term in index funds during market corrections.

Fear of loss

Analysts, traders and experts come up with their forecasts and estimates for levels of the market. In the last couple of years, we have seen the market joyride and scale new ups and downs. Initially, the market euphoria drives everyone to the markets.

The investing decision may not be based on fundamentals or price but rather on optimism. However, when negative news hits the market, the expected return from that investment suffers because as the news spreads, pessimism builds up. High level of negative sentiment leads to panic selling. Investors tend to sell their holdings thinking that they can at least protect capital from the fluctuations of the market.

Ultimately, the fear of loss forces many of us to take further hit on that investment or prevent us from buying despite extreme market lows. Primarily, our investment goals should drive the buy or sell decisions instead of the market sentiments.

More specifically in this context, we derive the investment philosophy of Peter Lynch, one of most successful investment managers.

Lynch believes that "Investing without research is like playing poker without looking at the cards" which means that you better know where you are putting your money.

Lynch suggests that both the PE (the price earnings ratio which gives an idea on how cheap a stock is) and growth prospects of a company are important while evaluating an investment. Hence, it is critical to understand and evaluate what we intend to buy and how it is going to help our finances.

Also, he states that you never time the market but should rely on long-term investing. So, the temporary fluctuations in the value of your investment should not concern you.

Rather, a fall in markets can be looked upon as an opportunity to invest further or simply be ignored. Rupee cost averaging is a useful technique to reduce the cost of investment. When the market tumbles, you can pick up a security at an attractive value, effectively reducing the initial cost of investment into that security.

Suppose you had bought 10 units of a stock A at a price of Rs 500. Due to market movements, the price falls to Rs 200. When you add another 10 units, your average cost for 20 units comes down to Rs 350.

Book profits? Yes, set profit target!

Warren Buffet follows the two basic tenets of investing: Rule No 1: Never lose money and Rule No 2: Never forget rule No 1.

One cannot be 100 per cent right all the time. Even Buffett has had his share of hits and misses. Having said this, obviously there have been significantly more successes.

Buffett in his quote, "Be fearful when others are greedy and greedy when others are fearful", clearly reinforces the importance of profit booking on certain holdings. Most of the investment planning requires you to decide whether to buy or sell a particular security, increase or reduce exposure to some holding or else to just hold on to some security.

Investors need to create their own plan and threshold for each investment. Generally, investors show certain indolence towards rebalancing the portfolio. If your investment makes sizeable gains, then a marginal profit-booking and rebalancing is essential.

Investors can set a target allocation and target return on their investment.

Let's say you are fine with 30 per cent return from the banking fund in your portfolio. Once the sector hits the targeted return, you can book profits and move the capital gains into a fixed income fund.

Else, you can hold on to your investment. Even though the sector rises by another 10 per cent, you make additional gains. On the contrary, your downside is protected in case the sector performs badly.

Conclusion

Lao Tzu, a poet, once opined, "Those who have knowledge don't predict. Those who predict don't have knowledge".

If anyone could really predict the future then all astrologers would be millionaires. As investors, we can follow some basic principles to optimise our returns irrespective of market cycles.

In this article, we introduced a few insights about investing by three successful investment gurus. The investment goals may differ for every investor but what remains true is long-term value and growth-driven investing with timely booking of profits.