1. Loss aversion causes investors to shy away from stocks; therefore, stocks earned very large returns relative to risk free government securities. 2. When the stakes are smaller, people actually become more tolerant of risk, not less tolerant. 3. There are 2 main implications of investor overconfidence. The first is that investors take bad bets because they fail to realize that they are at an informational disadvantage. The second is that they trade more frequently than is prudent, which leads to excessive trading volume. 4. The departure of price from fundamental value does not automatically lead to risk-free profit opportunities. In fact, the "SMART MONEY" may avoid some trades, although they have identified mis-pricing. Why? Because of non-fundamental risk, meaning risk associated with unpredictable sentiment.
1. Many investors will not sell anything at a loss. They don't want to give up the hope of making money on a particular investment, or perhaps they want to get even (equal to purchase value) before they get out. The "get-evenitis" disease has probably wrought more destruction on investment portfolios than anything else. Investors who accept losses can no longer prattle to their loved ones, " Honey, it is only a paper loss. Just wait. It will come back." 2. People are not uniform in their tolerance for risk. It depends on the situation. Many appear to tolerate risk more readily when they face the prospect of a loss than they do not. 3. Dividends are labeled as income, not capital. And investors tend to frame dividends as income, not capital. Again, this is frame dependence. Investors feel quite comfortable choosing a portfolio of stocks that feature high dividend payouts and spending those dividends. 4. Imagine someone who makes a decision that turned out badly and engages in self-recrimination for not having done the right thing. REGRET is the emotion experienced for not having made the right decision. REGRET is more than the pain of loss. It is the pain associated with feeling responsible for the loss. 5. REGRET minimization also leads some investors to use dividends, instead of selling stock, to finance consumer expenditures. Those who sell stock to finance a purchase, only to find that shortly thereafter the stock prices soars, are liable to feel considerable regret. 6. There are several emotional issues regarding loss and gain, the most fundamental of which is that people tend to feel losses much more acutely than they feel gains of comparable magnitude. This Phenomenon has come to be known as LOSS AVERSION.
1. People commit errors in the course of decision making; and these errors cause the prices of securities to be different from what they would have been in an error-free environment. 2. Investors overreact to both bad news and good news. Therefore, overreaction leads past losers to become under priced and past winners to become overpriced. 3. Disposition Effect: Investors are predisposed to holding losers too long and selling winners too early. 4. Long term earnings forecasts made by security analysts tend to be biased in the direction of recent success. Specifically, analysts overreact in that they are much more optimistic about recent winners than they are about recent losers. 5. When people are overconfident, they set overly narrow confidence bands. They set their high guess too low and their low guess too high. 6. Conservatism: Most of the security analysts react to earnings announcements: They do not revise their earnings estimates enough to reflect the new information. Consequently, positive earnings surprises tend to be followed by more positive earnings surprises, and negative surprises by more negative surprises.
Your pay cheque gets hiked every year and when you change a job it takes a leap, but our goals
remain same and so does the amount getting invested. A yearly hike is the right
time to increase your investment amount every year.
Another reason,
why a stepped SIP is required is that, when you plan your goals you assume a
certain rate of inflation, but what if in a tenure of 20 years there let’s say
a step up of 2% in the rate of inflation? Stepping up your SIP can certainly take
care of this possibility. And if not done, it only results into spending.
Reason 2 for
increasing your SIP that, if you have aggressively kept your returns
expectations. Say, 15% and your investments are still able to return 14% p.a.
which is still a good return. But with this short fall, you might fall short of
some amount when you reach your goal.
Reason 3, we
advise to shift your equity investments to debt when you are within 3 years of
reaching your goal. Debt will give lesser returns than equity, but we had
assumed returns what equity could give for the entire investment duration, so
this shortfall is also what a step up SIP, can easily accommodate.
Reason 4, if a new
goal gets added to your financial plan, you can attach this stepped up SIP to
that goal. This will certainly ease your burden.
Reason 5, as SIP
is a discipline, another disciplinary step for stepping your SIP each year can
do magic to your end corpus.
Let us take an
example and see what magic can a step up SIP create.
Today we are going to
talk about 3 fundamentals of investing
which can make you way richer than a friend of yours who earns same as you do,
but does not invest the way you do.
The 3 fundamentals are:
Start early
Invest regularly
Choose the right investment vehicle.
Let us take an example to see how long term investing can
work:
Had you invested Rs. 10,000 to buy 100 stocks of WIPRO in
1980, it would have made you immensely rich, see how:
Year
Bonus
No. of shares
1981
1:1
200
1985
1:1
400
1986
Price split to Rs. 10
4000
1987
1:1
8000
1989
1:1
16000
1992
1:1
32,000
1995
1:1
64,000
1997
2:1
1,92,000
1999
Price splitto Rs. 2
9,60,000
2004
2:1
28,80,000
2005
1:1
57,60,000
2010
2:3
96,00,000
2017
1:1
1,92,00,000
Today WIPRO’s stock price is 288.60 (as of 15 Dec 2017). So,
your holding today would amount to around Rs. 556 crores with a CAGR of 42.94%.
Now, we are not tempting to by WIPRO. This example is like
the hen giving golden eggs. We don’t know if any company can give you such
returns now. But what we want to stress is long term investing can deliver
excellent results.
Private players stepped into the mutual fund industry in
1993. So, MF history is not that old like stocks to quote and example here, but
there are funds which have given above 20% CAGR since inception. Now, if the
magic MF investing can show in the long term can overpower this WIPRO example
or no, is what only time can tell.
Let’s take an MF example.
Mr. A invests Rs. 1.5 lacs in PPF each year for 35 years.
PPF average rate assumed 7.5% p.a.
Corpus created 2.55 crore.
Mr. B invests Rs. 1.5 lacs in small and mid cap funds,
giving returns of 15% p.a. for 35 years.
Corpus created 18.57 crore. And some good small and mid cap
funds have given returns way above 15% of returns p.a. since inception. So,
just imagine the kind of corpus which can be generated
So invest regularly and see that you invest in the right
kind of vehicle. Now, when investment horizon is more than 10 years away, you
should invest in small and mid cap funds which have potential to deliver
highest returns. Once, category is finalised, choose the best fund on all
qualitative and quantitative parameters.
These days, we are receiving lot of queries regarding FRDI (Financial Resolution and Deposit Insurance) Bill 2017.
Everybody is asking "Are my Bank Fixed Deposits safe or not?"
Well the answer is Yes and No both. Why are we saying so?
Are your bank Fixed Deposits safe?
Answer is Yes they are safe, If you know your bank well and how well they are managing your money.
Answer is No they are not safe, if your bank is not managing your money well.
Now you will say Banks do not manage my money, I just deposit it in FDs and they give me GUARANTEED interest every month or quarter or year. So, friends there is no such guarantee a bank can give you. Only Rs. 1 Lakh deposit is insured. It is all in your mind that it is guaranteed, the herd mentality has forced you to think like that. I am not at all suggesting your money is not safe in banks but if your bank is not managing your money well then it is not safe.
Now, how you will come to know that whether your bank is managing it well or not. Just look at their NPAs and you will come to know. Are these numbers rising at quarter on quarter basis? Are they making more and more provisions for fresh NPAs? How is their Capital Adequacy Ratio? Are they well capitalized?
Now you will say we are not experts to do all these things. There are experts available in society, approach them. It is your hard earned money, you will have to know where it is invested and how well it has been managed.
We should not blame our government for this bill. Actually these PSU Banks have forced our governments to act like this (it does not matter whether it is BJP or Congress). A strong government will always take such tough decisions for long term benefits and protection of money. We just can't live in denial for all the time.
This particular bill will force us to ask some difficult questions to our banks. If our governments are running in deficits then how will they be able to bail out these banks every time. Somebody will have to fix this problem once and for all. And this is our chance to do that. Government is giving more power to bank through "Bail In" clause. As spider-man's uncle said "With more power comes more responsibility". And if these banks will not behave responsibly they will loose their market share to more powerful but more responsible Bank or any other institutions who will manage your money well.
So, start asking your relationship managers and branch managers some difficult questions. Your money will always be safe in strong banks or strong institutions (with no or at least low NPAs).
We will try and bring more details in coming blogs. Until then Happy Questioning !!!
Now that, we know our
cashflows, our goals and options to reach our financial goals with, let’s look
at two more things which should be put in place before we start investing.
Below is hierarchy of
Investment needs which should be taken care of in the said particular order:
1. Contingency Fund
2. Life insurance, critical illness cover, disability cover
and medical insurance
3. Short Term Goals
4. Medium and Long Term Goals
So your contingency fund
should be ready first and it is something described by the expense ratio which
should be kept ready first.
Expense ratio:
(Amt in savings
account+FDs+cash)/monthly expenses = 6 for salaried people
=
12 for business people and professionals
Expense ratio tells us
what amt of contingency fund we should be always ready with us in case of
situations like job loss, sudden medical expenses, etc.
Eg. If you are a salaried individual and your
monthly expenses are 50K then you should have 3 lacs in savings account + FDs or
liquid funds and cash.
If you are a professional
or a business man and your monthly expenses are 50K, should have around 6 lacs
in savings account + FDs or liquid funds and cash.
The expenses ratio is 12
for professionals or business men as their income is variable and monthly
expenses are constant. Keeping funds in liquid format would help set money
aside from good months for months when there is less income.
In case your contingency
fund is not ready, put this as your first short term
goal, fulfill this first and then move to other goals.
After expense ratio, your
medical insurance with critical illness cover and accidental disability cover
and your life insurance should be in place, and then you should move to your
short term goals and then your long term goals. It no where means your long
term goals are less important, what it means is, you should be ready for sudden
events like job loss, health issues and life loss first, then short term goals
which you have no alternative for or which cannot be push beyond 3 yrs and then
make investments for your long term goals.
To understand these concepts in detail, Please watch following video.
