Wednesday, April 7, 2010

Part 13: Marketing gimmicks and investor psychology

“This is your only chance to invest in the New Fund at Rs.10! As the NAV rises later, you will have to pay more!”  And you rush to hand in your money. What difference does it make what NAV you invest at? But ask the marketers. It works!

There is a fund house that is advertising heavily that they pay regular dividends out of their funds.  Assume you are young (which most of you are) and you are investing for the long term.  You would in that case want to invest in a fund for the long term and not keep taking the money out. As we saw earlier, for the power of compounding to take effect, you have to keep your money invested for the long term without dipping into the dividends.  In this case, every time you receive a dividend, you would have to reinvest it somewhere.  And where does the dividend come from? It comes from your own corpus, and the moment the dividend is declared your NAV drops to that extent.  Why then is it an advantage that the fund declares frequent dividends? 

The insurance company runs a highly sentimental ad that shows the father taking his child out for a walk by the sea, and dreaming about his future. Or the wife coming home to find her husband in what she thinks is a dead state.  Some clip like that is followed up by the conclusion that you should invest in a ULIP. Where is the connection? If it’s insurance they are selling, they should be selling you a pure Term Plan. If it is investments they are peddling, they should be talking about pure returns. As per IRDA regulations, they are supposed to put “Insurance is the subject matter of solicitation” at the end of every message.  They should change that to “Your emotions are the subject matter of exploitation”.

It’s the month of February, and you have to invest Rs.50,000 in tax saving schemes.  You have done all the homework and have zeroed in on three schemes, all of which are equally attractive.  What do you do then?  You split your money into three portions, and invest in all three schemes.  Why would you want to do that?  All of them are almost risk-free since they are guaranteed by the Government of India, and offer the same returns.  Perhaps you get more satisfaction by having more pieces of paper in your hand, and more items to keep track of. 

Instead of taking one insurance policy for a life cover of Rs.10 lakh, you buy two ULIPs, one endowment, and one money-back, all totaling up to a cover of Rs. 10 lakh.  You obviously spend more time thinking about the options, cutting the cheques, and keeping track of each of these policies. Why do you not just buy one policy for Rs.10 lakh?  Since you work more to keep track of them, do you feel more vindicated that you are doing something?  When it comes to investments we frequently fall into this trap. In the absence of more money at our disposal (which is true for all of us – this lack of money) we try to make up for it by more activity. We have all been brought up with the virtues of working hard and working more dinned into our heads since childhood.  In investments, as in other areas of life, we don’t often question the need to work harder – we just do, and it makes us feel better!

Your broker keeps calling you to tell you which stock is up today and which is down. NDTV and other news channels constantly run tickers at the bottom of the screen on stock prices which change by the minute. You have loads of buy and sell recommendations thrown at you. Some of them say that you have to target a return of x% and then sell.  Sell and do what?  Buy another stock of course! You sell
Company A and buy Company B, and your friend sells Company B and buys Company A.  Both of you are happy that you are constantly active in the act of making your money grow. Who benefits out of all this activity?  I do not know if you or your friend benefit, but the broker certainly does.  His commissions are made on executed trades. He makes money only if you buy and sell, not if you do nothing. Hence, it is in the interests of the trade to make you constantly trade!

Every time you buy and sell, you lose about 1 to 1.5 percent.  If you do this on average three times in a year, that’s 3 to 5% gone.  Out of your return.  Over the long term, when you compound the losses over several years, what would it be?  The only reason why you would buy a stock is if you consider a company as valued far below its intrinsic worth, and you would sell if the converse were true.  Why do you think the intrinsic worth of a company would keep changing on a day-to-day basis when it is dependent on the long term prospects of the company? Even if you were taking a timing call on the market, that would not vary on a day-to-day basis.

But try sitting tight and not doing anything and you will feel miserable.  It’s human psychology. You want to be doing something all the time, or you can’t seem to justify your existence, even to yourself. Investing is as much about fighting the markets as it is about fighting yourself!  If you invest directly into the stock markets, you should check the stock prices only once in a long while (what is long, I leave it to you to decide – Warren Buffett would say a few years), and act only after due deliberation. If you are not the kind to invest directly into the market, but prefer mutual funds, then pick a few (very few) mutual funds and stick to them for reasonably long periods of time.  Review fund performances once in a year or something, and adjust your asset allocations slightly to match changed circumstances. 

Discipline in this case, is to consciously try to do less!  I shall refrain from writing more – bye till the next issue!

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