Persistence and discipline are key to creation of wealth in the long term. Time is your strongest ally in helping your wealth grow multifold.
Neha, aged 24 and working at a media company, came to me and said, "I have been a keen follower of various business channels and have subscribed to a few newsletters as well. My online trading site also gives me a lot of tips. However, my portfolio is down by 55 per cent. I can take reasonable risk as I have no dependents. Can you help me on my equities so that I am able to get the best returns? Considering that there is so much of volatility, I would like to seek professional advice. I would also like to know whether I should be investing in direct equity like I have done in the past or through mutual funds. Or should I just be investing in the bank fixed deposit?"
Timing the market -- A popular 'myth'
Nobody really knows the peak and trough -- the market operates on macro-economic factors and the unpredictable human sentiment. The two prominent human sentiments which drive the markets are -- Greed and Fear. When the markets tank, panic grips even the most elite investor into take wrong decisions.
If one looks at aggregate mutual funds or equity data, it is evident that a lot of investments happen near market peaks and investors even pulling out at market lows. Studies on past data of the sensex have shown that it is almost impossible to time the market.
Ironing out volatility -- staying invested for the long term
Equity investing is inherently risky; most people burn their fingers and swear off the markets until its time for the markets to correct. Time alone can be the saviour in ensuring that the intermediate volatilities are ironed out, cutting your losses significantly. The table below illustrates that investment in the sensex in the long term would lower the probability of loss:
Source: BSE India; Data for Yr ending Mar (Every Yr)
If your time frame is below one year, then equity is simply not the place to be. An average of three-five years is ideal to look at equity investments. You can accommodate equities as a part of your portfolio if you are planning for a key milestone arising in the future, then you can include equities as a part of your portfolio. Markets in developing countries like India will always rise as a long term trend, with a sprinkling of highs and lows along the way.
Disciplined approach
For someone like Neha, who is salaried, mutual funds will be an ideal choice; unless you possess exceptional expertise, also having sufficient time is another criteria for direct equity investment. Mutual funds are relatively safer -- especially the balanced and diversified equity, with a slight bias towards largecap equity.
Mutual funds also have the option of investing on a monthly basis, which will help average out your cost is a disciplined way. The trick is not in buying at highs and selling at lows but investing regularly. A long term SIP is best for a young investor who has time on their side. If one had invested Rs 10,000 per month for the last 10 years, one would have ended up investing Rs 12 lakhs in this period. A ten-year SIP ending October 10, 2008 would have delivered the following returns:
For a disciplined investor, market volatility does provide an opportunity to enhance returns. My advice to Neha was to keep it simple -- go in for long term disciplined investing and invest predominantly in SIPs into equity mutual funds rather than trying to time the market.
Tips for the Week
- Invest in equities or equity mutual funds with a minimum 3-5 years timeframe.
- Use direct equity if you have the expertise and the time to track the market regularly.
- Don't invest by market sentiment. It is likely to be opposite of what you should be doing.
- If you are starting off in equities, use mutual funds -- diversified and balanced mutual funds are better options.
- Use the systematic route to create a discipline and also effectively average out the cost.
- Align your equity investments with your key long term financial goals.
A CFA-PGDBA, Anil is the founder & CEO of Right Horizons, an end-to-end investment advisory and wealth management firm.
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