Monday 9 November 2009

Some interesting stuff on Behavioural Economics


Some interesting stuff on Behavioural Economics
- Before my holiday
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Going on a holiday


Going on a holiday

Dear Friends,

Am going off on a longish holiday for 3-4 weeks. I'm unlikely to be blogging during this period.

Once I'm back, I'm sure that I'll be even more energized than ever, and will come up with many more useful and interesting posts.

Do check out from time to time, but certainly come back to this blog in the first week of December, 2009.

Bye for now!

Regards,
N

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Friday 6 November 2009

Which month is the best time to redeem Equity Mutual Funds?


Which month is the best time to redeem Equity Mutual Funds?
A few words of caution: This post might be of interest and utility only if you are:
  1. Investing both in Shares and Equity Mutual Funds
  2. Reasonably financially literate (so that you'll follow the substance of what I'm talking about - nothing complex, but slightly boring stuff nevertheless)

The above question, according to experts, is probably irrelevant.

They'll probably say that your redemption decision should be driven by factors such as:
  • When you need the money,
  • When markets are generally overvalued,
  • When the PE is too high, etc.
However, let me rephrase the question.

If you need to generate some cash for a specific bulk expense from your shares or equity mutual funds, should you be indifferent about whether you sell shares or redeem mutual funds?

Or is there any logic in redeeming mutual funds Before selling shares? If so, will the answer be different in any specific month of the year?

I don't have any definitive answers Yet.

However, I've started developing a hypothesis about the same. Let me share with you the broad idea.

Well, I happened to review the portfolio (which I manage) of a family member for the month of October 2009, and I found something curious:

% Change over the previous monthChange
Equity MF (A collection of Equity funds from different fund houses)-2.16
Sensex-7.38
Nifty-7.38

In all preceding months, through thick and thin, through bull markets and bear markets, the above figures used to be somewhat comparable to each other. I've never noticed a significant difference in the past. Of course, I'll need to re-check the data over the years to see if such differences have occered in the past either for this individual or for any of the other portfolios that I manage.

The difference in October 2009 appears to be huge. While the Sensex and Nifty have fallen by over 7%, the Equity mutual funds net worth has declined by just above 2%. Amazing indeed. An outperformance of over 500 basis points. Within a single month.

Have the fund managers suddenly become "super-efficient"? Or have they got plain lucky?

I've been in the market for way too long to believe in either of the above possibilities.

I delved deeper into the matter and did some quick research. I found something very basic and interesting.

This family member had received dividends (interim and final) on many shares held by him during the month of October. Obviously, many companies forming part of the Sensex & Nifty would also have paid out dividends during October (and hence gone ex-Dividend).

This implies that all those companies which had gone ex-Dividend in October 2009 would have started quoting at a price duly reduced by the dividend amount by the end of October, thereby reducing the Sensex and Nifty levels correspondingly.

On analysing the Mutual fund portfolio of this family member, most of the Equity Mutual Funds in his person's portfolio had Not Declared any Dividend during October 2009. However, most of these Equity mutual funds would have Received dividends from companies held by them in their portfolio. To that extent, the NAV of these Equity Mutual Funds would, as on October 31, 2009, be quoting at levels which would include the impact of dividends received by them.

This could be one of the possible reasons for he huge difference of 500 basis points in the performance of Equity Mutual Funds vis-a-vis Sensex / Nifty during October 2009.

If my above hypothesis is indeed true, while you can be indifferent about whether you sell shares or redeem equity mutual funds in other months, in those months when you receive lots of dividends from companies whose shares you own, you must prefer to redeem equity mutual funds rather than sell shares. Like in October 2009, for instance.

As a corollary, if you must either invest in shares or equity mutual funds in months such as October 2009, obviously, you must prefer to invest in shares directly rather than investing in equity mutual funds.

Think about it. Perhaps there's a grain of truth.

Also, do give me your feedback on the same after making a similar study of your own portfolio.

Regards,

N

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Wednesday 4 November 2009

Power of Trading

Power of Trading

Many people misunderstand the concept of

  • Long-term investing - To mean that one should sell only when one needs the money
  • Asset Allocation - To mean that one should have a by-and-large-fixed proportion of surplus money to be invested in different asset classes at any given life situation (age, number of kids, etc.)

Both the above are completely wrong. I'll explain in greater detail in later posts.

In this post, I'm going to share with you hypothetical figures of the difference that one can make with

  • Periodic trading, ie., periodically booking profits and re-entering at lower levels
  • Slightly higher levels of returns by allocating a larger share in riskier asset classes.

Take a look at this table:

Power of Trading, rather than holding long-term! Wonder if it is feasible???
Initial Amount Invested
Annual Return
No. of Years
Final Value of Investment
 
 
 
 
 
 
 
Impact of buying shares at just 3% lower cost and trading periodically so as to get just a 2% additional return annually
97,000
1.20
10
600,598
 
100,000
1.18
10
523,384
 
 
 
 
 
 
97,000
1.14
10
359,600
 
100,000
1.12
10
310,585

You'll realise something that ought to be obvious:

  • A 6% higher return can mean an enormous difference to your portfolio value at the end of a decade. Hence, do ensure that you allocate a higher proportion of your disposable surplus in riskier asset classes like equity if you are looking at the long term
  • A strategy that involves periodical profit booking and re-entering at marginally lower levels has quite a significant impact on your portfolio value at the end of a decade. Hence, make it a point to book profits regularly. This will also ensure that you
    • Review your portfolio regularly
    • Cut your losses from unintended dud investments far more quickly

Think about it!

And Act!

Regards,

N


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