Back to Basics

For most investors, most of the time, doing nothing is the right choice

Iftikhar Bashir
Srinagar, Publish Date: Sep 17 2018 11:05PM | Updated Date: Sep 17 2018 11:05PM
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The other day I was discussing about qualities like simplicity and wisdom in investing with a friend and the following quote came to my mind - “The art of being wise is the art of knowing what to overlook”. Talk about investing, when one starts studying investors and investments with an open mind, it doesn't take long to understand that the more complex a financial product or service, the worse it is for the buyer. To put it another way, if an investor does not understand a financial product or service, then it isn't right for him, regardless of how attractive it may otherwise appear. This means that financial products must be simple, straightforward and easy to understand as far as possible. For example, just about the only 'investment' that is suitable as the way for a small child to save pocket money till the next month is to keep it in a box. The money is there, and when the kid needs it, he or she can take it out. That's it.

 

What does the activity of investment ideally consist of? A lot of people think that investing consists of actions like studying investments, choosing them, monitoring them, looking for new ones and so on so forth. In other words, a lot of activity. If I think of the actual activity that should take up most of the time of investors, then it should be nothing. For most - almost all - of the lifetime of an investment, you should be doing nothing about it. The bulk of the activity (if that's the word) of investing is waiting. Waiting for months and years while your investment grows, powered by the monthly drip-irrigation of your SIP instalments..That's absolutely fine, except when investors think it isn't. Much of the investment information industry is busy giving the impression that investing consists of doing things and investors who do more, will earn more. In most activities in life, that is probably true. Whether you are an entrepreneur or a salaried employee, you will probably do better professionally and earn more if you have what is called a bias for action. Counter-intuitively, this is not true for investing. Investors who think that this is true, act when they shouldn't and do worse than others. As someone said, a bored investor is a dangerous thing. 

 

This need for simplicity can actually be extended much further. All investments are of two types - debt or equity. By themselves, debt or equity are very straightforward. Debt is the simpler of the two. You give a loan to somebody who can put it to some use, like a bank or some other business, for example. After sometime, your money, plus a little extra, is returned to you. Equity is almost as simple. Someone wants to run a business but doesn't have enough money. So you contribute some money and become a business partner, in proportion to the money you contributed. So if one per cent of the money is yours then one per cent of the profit is yours and so on. However in practice, debt and a equity (specially equity) are slightly more complex but if you keep a clear-head there's nothing that can't easily be boiled down to the basics. There could be different ways of actually investing but it all comes down to debt or equity. For instance, your provident fund is just a loan given to the government. And mutual funds are really not an investment at all but an entity to whom you give the task of investing for you. Every investment can be fitted into and understood in this debt-or-equity framework. For example, buying a property is clearly an equity investment. In this entire picture of investments that most of us make, the oddest creature is actually Insurance. The reason is that insurance itself is not an investment and cannot be simplified to any kind of debt or equity framework. Insurance by itself is just a risk cover whereby you pay a premium for a certain term and if you die within that term, the insurance company will pay your survivors/nominees. Unfortunately, from being a potentially simple idea, the buying of insurance has been made into an incredibly complicated exercise by mixing it with investment. When you buy insurance the part of your money that will go into investment and the part that will go for covering the risk of dying is an opaque mix up and the cross-flow of investment returns and risk cover is practically impossible to unravel. The only reasonable thing to do is to keep insurance and investment completely separate by buying only term insurance, which is pure insurance. Separately, you should make investments that are pure investments and simple to understand as investments only. This sounds like a paradox but the test for the right kind of insurance is whether the insurer will ever return any money to you. You should never buy a policy in which you get anything back. If you are getting any money back, then your policy is actually an unhealthy mix of insurance and investment. Unfortunately, term insurance is so good for customers because it's cheap and for the same reason it's a product that insurance companies are not too fond of selling. But that's a different story.

 

Right now, the Indian equity markets are near an all-time high. Most investors, especially those who have invested steadily in equity mutual funds over last few years, are sitting on humongous gains. It's the kind of time that provokes action, through optimism and a desire to fully take advantage of the situation. Resist the temptation. It's a time to do nothing different, nothing extraordinary. There's a saying about travelling, “that getting there is half the experience”. One could equally say about investments that doing nothing is most of the experience.

 

Basically, for most investors, most of the time, doing nothing is the right choice as Knowledge is a process of piling up facts and wisdom lies in their simplification.

 

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