How we sense risk of investing a lump sum (five lakhs) in stocks: survey results

How we sense risk investing a lump sum in stocks

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Investors sense the risk of investing a lump sum in stocks in different ways. Here are two dramatically different Facebook poll results on the subject conducted at Asan Ideas For Wealth (AIFW) and what we can learn from it. This should also be of use to investment advisors in understanding how clients perceive risk. After all, “risk appetite” often means “risk ignorance”.

Poll no 1 On the morning of 31st Aug 2019, I started this poll at AIFW. “Kindly participate. I have Rs. 5 lakh and wish to invest in equity (I am not worried about the current market condition as my need is “long-term”). How should I invest?” There were two options given:

  • Immediately in one shot: Votes: 87
  • Gradually over a few months: Votes 258 (~ 75%)

So, as expected most people preferred investing gradually over a few months. After all, it is not 5 lakh, it is FIVE LAKH! No surprises here as most investors are worried about the market crashing the day after we invest.  These “I am not worried about the current market condition as my need is “long-term” are clearly not important when such a large sum is at stake. 

I have earlier shown here – Investing a lump sum in one-shot vs gradually in an equity mutual fund (backtest results) – that gradually investing (manually or via STP) does not in any way lower risk or enhance returns. All it does is provide false psychological relief.

Gradual investing does NOT or need not mean a “STP”! You can simply invest some amount once a week or a month. Please recognise that the STP is a tool for the AMCs and sales guys to lock-in your money.

Poll no 2 On the evening of 31st Aug 2019, I started a second poll: “Today I started a poll about investing in one-shot vs gradually in the market. I realised I did not phrase it right. So I would like to start a new poll if you do not mind. Kindly participate.
=============================
I have an amount with me and wish to invest in equity (I am not worried about the current market condition as my need is “long-term”). The amount is less than 3% of my current net worth and about 6% of my equity holdings.
How should I invest?” The same two options were given.

  • Immediately in one shot: Votes: 116
  • Gradually over a few months: Votes 131 (~ 53%)

Voted polled the second time is 247, a bit lower than the 343 the first time, however, we still can learn quite a bit. From a clear majority for gradual investing, the votes are not split almost 50:50. Why?

When investors gauge that Rs. five lakh with respect to a net worth or current equity holdings, it looks small. A good half of the participants recognise that when more than Rs. 80 Lakh is already in the market, how does it matter if I add Rs. 5 lakh more? After all, if the market crashes tomorrow, the loss from that Rs. 80 lakh will be higher in value.

The change in logic is because investors now can measure how big the lump sum is. When it is only Rs. Five Lakh it looks big. However, when divided by the net worth or the equity holdings, it looks small or at least not as big.

After all, you cannot gauge if the market is over-valued or under-valued if I just gave you the current Nifty price. You need to divide it by the earnings (or book value) to arrive at the PE (or PB) ratio to determine the state of the market.

The point is, high or low is a ratio and not absolute. It is good that at least half the participants understood this. Why would someone with 1.6 Crore net wroth with half that amount already in the stock market fear to invest a mere Rs. five lakh in one-shot?

A mere 6% fall in the market for this person would result in a “notional” (I hate that word) loss of Rs. five lakh. And 6% fall is not even a “crash”!! The answer IMO lies in fear of regret.

I wonder if this can be referred to as cognitive dissonance. In any case, the fear here is not the market volatility, but our action.

If the market crashes the day after I invest Rs. 5 L, I am entirely responsible for that loss. I will be able to stop thinking about it. I will keep scolding myself: why did I not spread it over a few weeks?

This is my opinion of course and I could well be wrong. However, this regret is something that I see every day in others and of course harbour it too.  This regret is no different from a newbie complaining that the market moved up on the day of my SIP debit.

Investors and advisors will have to address this sense of regret. We need to train our minds to stop looking at loss as “absolute” and have a holistic, long-term view. It is not easy, but with training it is possible. In my investor meets I tell young earners to tell themselves, ” soon I am going to gain lakhs in my portfolio every day, I would lose lakhs every day too, but I am going to take both in my stride and stay grounded”

Here is a paraphrased, shortened version of IF by Rudyard Kipling for inspiration

If you can keep your head when all about you
    Are losing theirs,
If you can trust yourself when all men doubt,
If you can wait and not be tired by waiting,
If you can dream—and not make dreams your master;
 If you can think—and not make thoughts your aim;
If you can meet with Triumph and Disaster
    And treat those two impostors just the same;
If you can force your heart and nerve and sinew
    To serve your turn long after they are gone,
And so hold on when there is nothing in you
    Except the Will which says to them: ‘Hold on!’
Yours is the Earth and everything that’s in it,
    And—which is more—you’ll be a Man, my son!
Listen to the full poem here.
What are your interpretations of the two poll results?
Do share if you found this useful

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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6 Comments

  1. “If the market crashes the day after I invest Rs. 5 L, I am entirely responsible for that loss. I will be able to stop thinking about it. I will keep scolding myself: why did I not spread it over a few weeks? ”

    This phrase is exactly correct

  2. Professor, you have taught us that the entire invested amount is at risk when the market falls, invested through SIP or lump sum. And although the feeling subsides, I will feel that I should have invested slowly and not in one go.

    Also I think, a direct equity investor, who is observing the price movement of his selected stocks, will know if he should invest in one go or wait and accumulate slowly. Why forego the little gain that you can absolutely get by staying in debt and move in accordance with the price? This is one of the lessons I have learned, the gains may be negligible for others but good for me.

  3. For a newbie investor, it’s the sense of loss if the market falls the day after our investment. For an experienced investor it’s a sense of missed opportunity to buy more units if he had gone in gradually.
    So the feelings are totally different for newbie and seasoned investor really IMHO.
    As an experienced investor my lump-sum investment during big falls today are 5 times more than what I was doing 4-5 years ago because my total investment has grown up and old lump-sum is no longer big enough to make a difference.
    So this relativity is definitely a valid point.

  4. What I submit is a real case study and it is my own case.
    Asked my adviser how to deploy plot sale proceeds (16% of my net worth ) .
    I was advised in writing to invest in fund A and fund B in one shot on 20th April 2019.
    I decided to spread it over a time period and I am yet to invest the full amount.
    I opine my decision turned out to be correct since NAV of my investments so far is below NAV on 20th April.
    I would love your opinion about my action

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