Lessons from the Revival of Nifty Next 50

We have recently discussed the revival in investor interest in Nifty Next 50 – Nifty Next 50 outshines Nifty 50 by 41% – Time to buy? As pointed out, in 2018, many investors started investing in Nifty Next 50 index funds only to be frustrated by its performance over the next five to six years. Over the last year or so, the index has done well again, and as usual, investors are interested again. Here are some lessons from the episode.

1. All stock market predictions, suggestions, and investment decisions can be proved wrong or right if we wait long enough. No choice or strategy excels or underperforms all the time. Everything is a cycle with unknown repetition frequency.

2. (Almost) No one has the patience to endure these cycles. At the first sight of underperformance, they get jittery and want to invest in something else shiny.

3. After they invest, that shiny object begins to fade, and they look for something else shiny (including old choices). Shiny object syndrome is extremely injurious to portfolio health.

4. Recent underperformance or recent outperformance is the worst metric on which to base investment decisions. Yet, if you visit personal finance forums, it is clearly the only metric used. RIP financial literacy.

Past Performance Is Not Indicative Of Future Returns. Almost no one takes the disclaimer seriously. It should be the first thing they consider!

5. “Those who cannot remember the past are condemned to repeat it.” – George Santayana. This resurgence of Nifty Next 50 is nothing new. It has happened many times before. Meaning it has gone through poor phases many times before. If we do not appreciate the risk of using rolling returns, we will be surprised when the wind changes direction. See Nifty vs Nifty Next 50 vs Nifty Midcap 150 vs Nifty Smallcap 250: Return Comparison April 2024. Also, Watch my talk on active vs passive investing in India.

6. Everyone wants a diversified portfolio, but no one understands what it entails: Some investment or the other will underperform at any given time.

We are not too enthusiastic about this resurgence in Nifty Next 50. It will not last long. That is its nature. Only those who understand this and can stay invested through long periods of underperformance should choose the index.

So what should investors do? Besides avoiding the pitfalls mentioned above, Implement a goal-based investment strategy.

1. Understand when you need the money. If you are unclear, you can only save, not invest.
2. Know when to invest in what asset class: equity, fixed-income gold, etc. We recommend zero per cent equity for up to five-year investment durations, About 20%-25% for up to 10-year durations, and 50-60% beyond that. The rest is to be invested in fixed income. There is no need for gold or real estate (as an investment).
3. Have reasonable post-tax return expectations from each asset class. For example, expecting 18% from equity is silly, no matter how long the investment duration is and how good the portfolio management is. We recommend 10% post-tax from equity and 6% post-tax from fixed-income. These expectations should only be revised downwards in future!
4. Choose the right asset allocation. This means deciding to hold X% or Y% of equity so that (a) you can tolerate the volatility and (b) the amount of money to be invested for this asset allocation is possible and manageable (including future increase investment).
5. Rebalance your portfolio once a year, every year. Market volatility will increase or decrease the portfolio’s equity/fixed income percentage holding. Rebalancing is a way to reset the asset allocation to the desired one. See this video for more details.
6. Change your asset allocation in a step-wise manner. Many people say unsubstantiated things like “reduce equity in the last three years, before you need money” and so on. You need to reduce equity a lot sooner!

   Long term investors must have a solid systematic risk management plan by gradually de-risking their equity exposure. Our research – explained in the goal-based portfolio management course and incorporated into the freefincal robo advisor – shows that this has more than a reasonable chance of success regardless of market conditions. This is also explained here: do not expect returns from mutual fund SIPs! Do this instead!

7. Shift focus from returns to the target corpus. Too much time and effort get wasted on worrying about returns. It is a lot easier if investors focus on the target corpus. This is a variable target due to inflation and other logistics. So, each year, we need to redo the goal planning calculation.