Investors tend to display extreme behaviour. Most of them want the solace of risk-free returns without understanding the impact of inflation. A few who do understand this impact tend to obsess over ‘how much their portfolio made’. A look at why keeping things simple, with minimal effort and systematic investing, is all that is required to achieve all our financial goals.
Basant Maheshwari from The Equity Desk, made a brilliant point during a discussion. On 12th March 2006, Australia took on South Africa in a one-day game at the New Wanderers stadium, Johannesburg. Australia made a record score of 434. SA skipper Graham Smith is supposed to have remarked at the innings break that the Aussies were a few runs short! How true that turned out to be! South Africa managed to make 438 runs with a ball to spare!
Referencing this, BM said, ‘investing is not a game. Our target is not 435! The guy who makes 400 is also a winner, the guy who makes 380 is also a winner’. People who recognise this simple truth can manage money in a calm and contented way. Read more: The Contented Investor.
Power of compounding is always illustrated with two friends or two brothers. One who started investing earlier than the other. What if they both started investing at the same time? After 20 years of systematic (monthly) investing, A gets an XIRR of 17% (CAGR for periodic investing. See:What is XIRR?) and B, 20%.
So can we now conclude B has created more wealth than A? What if A invested more than B each month?
If B invests only 70% of what A does each month, they would both end up with the same corpus.
- Choose the right asset classes to build a diversified portfolio
- invest as much as we can
- invest as early as possible.
That is all that anyone can do. We have little control of the returns we get from volatile asset classes (regardless of investing approach). At least to a certain extent, we can control, how much we invest and how soon we start investing and how regularly we invest. So why not control the controllable’s alone?
What if A and B both had invested the same amount over the same duration? B, with an XIRR of 20% would have got a much larger corpus than A. Does it matter, though?
Both investors would have got a real return (above inflation). If both investors had investors enough for their goals, does the comparison make any sense?
In the investor workshops, I talk about how mutual fund selection does not matter and that spread in returns among funds is quite small (much smaller than the 25% to 17% difference between A and B). Some people react that even 1% difference in return matters over a long time.
Yes, mathematically it does. However, unless I choose direct mutual funds, I am not guaranteed of a 1% return difference. I have no way of forecasting which fund or which investment strategy would yield better returns in future. So why bother? Do what we are comfortable with, review periodically and hope for the best. Why be interested in what the other guy is doing?
Portfolios do not perform because
- most investors do no have a clear investment strategy
- of constant tinkering with the portfolio due to lack of conviction
- of failure to review performance with personal benchmarks.
When I say my personal expectation from equity is only 10%, I am surprised to hear comment like, ‘you are too conservative’, ‘why choose equity if you need only 10%?’ and the like.
Forgetting for a moment that getting 10% post-tax return from any other asset class is tough, I expect 10% only from equity because, lower the return expectation, the more I need to invest.
If I invest more in an asset class which could more than possibly exceed my expectations, I have created a corpus larger than necessary (hopefully). If I expect 10% and receive 15%, I am not going to gift the excess back to the AMC!
There is pure joy in systematically controlling the controllable. It allows me more than enough time to focus on the things that I love.