Thursday, 30 December, 2010

Intuitive Wealth Creation

Intuitive Wealth Creation

In the first issue of the recently launched magazine "ET Wealth", which came a couple of weeks back, there was an article featuring a 70+ man who has been ignoring ALL the traditional methods of investing in mutual funds. Interestingly, in the very next week, there was an "Expert Opinion" by, if I'm not mistaken, Dhirendra Kumar of Value Research Online, according to whom, virtually all the things that this 70+ man had been doing all these years was totally wrong!

Here are some of the things that the investor has apparently been doing for the past several decades, along with what is supposedly wrong with that according to traditional expert opinion:

Action - He's been investing in virtually ALL equity mutual funds, with a special focus on NFOs

Expert View - Involves over-diversification; Likely to result in dud holdings; NFOs are unproven quantities

Action - He's been investing in the dividend payout option

Expert View - For long term investments, the growth option is always better
Action - Investing in virtually every NFO of every Mutual Fund House.
Expert View - Certainly not the right approach - The NFO needs to establish its performance over a period of time before investing in that particular scheme. In any case, all necessary diversification can be achieved by investing regularly in 6-8 DIFFERENT schemes of 3-4 fund houses, preferably highly rated ones according to the ratings provided by organisations like ET, Mint 50, OLM 50, Value Research Online, CRISIL, etc. 
Action - Most of the disposable surplus, if not all, has been invested in Equity Mutual Funds.
Expert View - As one ages, equity exposure must be gradually reduced, with an increasing focus on debt funds and other fixed income products

Action - Over the past several decades, SIPs of small amounts have been made in a plethora of funds, resulting in holdings in more schemes and more fund houses than one can care to count.

Expert View - This is ridiculous. Involves investment in dud funds. Too much diversification. Administrative nightmare. Phenomenal paperwork. Even computation of income from such investments for filing IT returns will be a complex exercise.

______________________

However, the investor has done a few things perfectly, almost accidentally. This has resulted in genuine wealth creation that would be almost unimaginable for most investors, including supposedly financially savvy investors.

Here's the list of things that the investor has done right - for you and me to learn, internalise and follow:

  • ALL investments have been made through SIPs (Systematic Investment Plans).
    • This has resulted in avoiding the pitfalls of timing the markets.
  • He has almost indiscriminately invested in the entire gamut of equity mutual funds. This implies that he has invested relatively small amounts in each individual scheme as a percentage of the overall holdings.
    • Result - No single investment is large enough to "Catch the eye" and tempt him to redeem for any exigency. This further results in a "Buffett-like" holding period - virtually forever! If a sudden bulk expense (justified or otherwise) crops up, the very same "administrative nightmare" due to a plethora of funds protects him from redeeming his funds in a hurry.
  • All investments have been made in the dividend payout option
    • Result - Profit booking is automatic and done passively by our investor. Whenever the fund manager actually makes money (which is usually when the markets go up), he's likely to declare dividends. Obviously, excesses of the markets and volatility in individual scrips play out in favour of our investor.
      • When the market crashes due to extraneous reasons like the Harshad Mehta scam, Sub-prime crisis, etc., fund managers are less likely to declare dividends, but out investor continues to make SIPs
      • When the market booms due to extraneous reasons like the dot com bubble, "high-performing India Shining story", reforms by the government, formation of a stable government at the centre, etc., fund managers are more likely to declare "extra" dividends.
    • Obviously, the above results in our dear Investor deriving the benefits of "timing the market" without any specific efforts in that direction.
  • Our investor has been preferring funds with Low NAVs
    • Low NAV usually implies that the funds are gross underperformers. The regulatory environment does not allow the fund to swindle the investor and go away. Hence, chances are bright that one or more of the following will happen with such funds:
      • a better fund manager will come along and improve the performance
      • the fund house will be taken over by some other fund house resulting in improved performance
      • the stocks in the scheme which have been underperformers will start performing much better over a period of time
    • Result - Our investor ends up locking into such schemes at low prices. Thanks to his really Looooooooong holding period, these end up being surprisingly wonderful investments in the long run. For instance, I'm sure that he would have benefited from investing in tech funds subsequent to the dot com bust, in large cap funds subsequent to the sub-prime meltdown, etc.
  • Our investor has been investing in NFOs
    • While this can be a bad choice for lesser mortals with a holding period of less than a couple of years, this has proved to be an interesting strategy for our investor due to a multitude of factors:
      • NFOs are likely to grab undue management attention from the top brass of fund houses. Obviously, they would like to "prove a point"
      • NFOs are likely to be managed by relatively young fund managers under the strict supervision of the top brass. This would again result in "new and fresh" ideas from the young whiz kid, accompanied by the temporing wisdom from the top guns.
      • NFOs are likely to attract less number of investors because of the traditional understanding and guidance from advisors that you must stick to proven funds with a track record. Hence, the assets under management of such NFOs will be relatively small. Just ideal for an innovative fund manager to achieve significant outperformance vis-a-vis benchmark indices, as he will not be forced to invest in "boring, well-discovered" large caps due to liquidity factors.
  • Our investor, despite being a senior citizen, has still chosen to remain invested in Equity Mutual Funds
    • While this is also traditionally perceived to be "the wrong thing", it just so happens to be "Yehi Hai Right Choice, Baby" for this investor due to the following interesting reasons:
      • The very same "highly risky" Equity have miraculously been transformed into "Almost zero risk investments" due to the long holding periods.
      • The virtually daily receipt of one dividend or the other ensures that his routine liquidity requirements are more than met - very comfortably.
      • Considering the fact that he has a huge (and supportive) family, including a grandchild who has created an excel-based system to monitor his investments, there is no real risk of his investment details remaining unknown and hence unclaimed after his life time. Therefore, he'll end up not only enjoying a great quality of financial freedom during his life time, but will also end up bequeathing huge wealth to his family members in the years to come!

To conclude, this investor, almost intuitively, has ended up, in accordance to the most important piece of wisdom from the Graham & Buffett school of investing, ensured that he has focussed on "Time in the market, and not on timing the market". And, Einstein's 8th wonder of the world - The magic of Compounding - has been put to work almost as our dear investor's slave! No wonder he has built an enormous wealth over the years.

May more and more people learn the crucial lessons from this investor - not the superficial one of investing in all and sundry mutual funds!

Regards,

N


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