Friday, Sept 20 2024
Source/Contribution by : NJ Publications

Debunking 7 Misconceptions About Investing

Investing wisely is not just about knowing what to do; it's also about understanding what not to do. In the world of finance, myths and misconceptions abound, often clouding the path to financial success. These myths can make investing seem daunting or even unattainable for many aspiring investors. But fear not! By shedding light on these misconceptions, we can empower ourselves to make informed decisions and navigate the investment landscape more confidently.

In this article, we'll explore 7 common investment myths that you should stop believing.

Myth 1: Investing Is Exclusively For The Affluent

Contrary to widespread belief, you don't need to be swimming in gold coins like Scrooge McDuck to start investing. In fact, anyone with a modest sum can dip their toes into the investment pool. Today, there's a plethora of investment avenues tailored for beginners and individuals with limited incomes, making investing more accessible than ever before. For instance, you can initiate a mutual fund SIP with as little as Rs. 100 per month. You may wonder how far such a modest amount can take you in the realm of investing.

Here’s where the magic of compounding comes into play. Imagine you invested Rs. 2000 every month, 15 years ago into a fund that returns 12.64%. Today, your investment would have grown to over Rs. 10 lakh! If you started this SIP 30 years back, your investment would have reached over Rs. 70 lakh. That’s the incredible power of compound interest. (Assuming investment in Equity Fund and an average return of 12.64% p.a. as per AMFI Best Practices. Guidelines Circular No. 135/BP/109/2023-24 dated November 01, 2023.)

Myth 2: Relying On Savings Will Secure Your Future

While saving is essential for financial security, it's just the beginning. If you don't invest your savings in products that outpace inflation, your wealth could diminish over time.

For example, if inflation averages 5-6% annually and your savings lie in a bank account yielding 3-4% annually, your wealth will effectively erode.

Even if you opt for fixed deposits, most reputable banks now offer returns around 6-7%. After factoring in taxes (30% tax slab yields post-tax returns of 4.2-4.9%), these returns may fall short of the decade's average inflation rate of 5%.

(Period:- Inflation Rate: FY 2014 - FY 2024; 1-3 years Bank FD Rates as on September 2023)

(Source: RBI)

Therefore, it's prudent to diversify your savings across different asset classes such as equities, bonds, gold, and real estate. This strategy aims to outpace inflation significantly and build long-term wealth. It's not just about saving; it's about strategically investing in the right financial instruments to ensure a secure financial future.

Myth 3: Timing The Market Is The Key To Successful Investing

Timing the market involves attempting to forecast future market movements and making buy or sell decisions based on these predictions. While occasional success in market timing is possible through luck, consistently trying to time the market exposes investors to higher risks relative to potential returns.

For long-term investors, investing regularly is often more beneficial than waiting for significant market corrections. Long-term investors are better off investing regularly, as opposed to waiting for a big correction. Predicting when or if such corrections will occur is uncertain, and markets can continue to rise for extended periods before any downturn occurs. Therefore, waiting for a market crash may cause investors to miss out on substantial gains during upward market trends.

So, instead of playing the guessing game, it's wiser to focus on long-term investment strategies and remain invested through market fluctuations. Keep in mind, being in the market consistently surpasses trying to time the market.

Myth 4: Stock Picking Is the Best Way to Make Wealth

While it's enticing to try and pick the next big winner, stock picking is a risky endeavor that often results in disappointment. Rather than focusing on individual stocks, consider investing in mutual funds.

Myth 5: Comparing Investing to Gambling

Some liken investing to gambling because both carry the risk of losing money, and involve uncertain outcomes. However, investing is not akin to rolling dice—it's a deliberate pursuit grounded in research, analysis, and strategic planning. While risk is inherent, investing differs significantly from gambling. Unlike games of chance, investing empowers individuals to make informed decisions and exert some level of control over outcomes. Therefore, it's best to leave gambling to the casinos and approach investing with a rational mindset and a carefully crafted strategy.

Myth 6: You Can Rely On Past Performance To Predict Future Returns

While historical performance can provide insights, it's not a reliable indicator of future results. Market conditions, economic factors, and other variables can change over time.

Myth 7: You Need To Be A Financial Expert To Invest Money

There's a common misconception that successful investing requires expertise in finance. Investing can seem daunting at first, but it is no rocket science. With basic education and guidance, anyone can grasp fundamental principles and build a successful investment strategy. Another effective route is to consult an advisor. They can provide valuable guidance on various strategies tailored to your long-term objectives.

Conclusion:

Investing is a path marked by unexpected twists, turns, and occasional misinformation. By dispelling these 7 investing myths, you can navigate this landscape with enhanced clarity and confidence. Don't allow these misconceptions to hinder you from investing and securing your financial future.

Stay disciplined, exercise patience, and ensure your investment approach suits your financial circumstances. Focus on acquiring knowledge, begin with modest investments, and remain committed to a long-term strategy.

In the evolving landscape of personal finance, mutual funds have emerged as a versatile and accessible investment vehicle for a wide range of investors. As a mutual fund investor, you might be familiar with the various types available, like equity, debt, and hybrid funds. But, have you encountered solution-oriented mutual funds yet? If not, this blog is tailored just for you.

In India, Securities Exchange Board of India (SEBI) has categorized mutual funds into 5 primary classifications - equity funds, debt, hybrid schemes, solution-oriented funds, and others.

Solution Oriented funds, as the name suggests, are meant to serve specific purposes and hence provide ‘solution’ to specific requirements. Solution based schemes are particularly helpful for those investors who wish to build a corpus for their retirement or children’s future through mutual funds but lack the expertise to make decisions on fund selection, asset allocation, and portfolio rebalancing. They provide investors with the benefit of selecting customized portfolios based on their risk preferences and the specific objective of their investment.

The types of solution-oriented mutual funds that are available to the investors in India are:

1. Retirement Fund:

This fund is designed to help investors build a corpus for their post-retirement life. It has a lock-in period of 5 years or until retirement age, whichever is earlier.

2. Children’s Fund:

This fund focuses on long-term wealth creation to meet your child's future expenses like education, marriage, etc. It has a lock-in period of at least 5 years or until the child reaches the age of majority (whichever is earlier).

Retirement and children’s education or marriage are long-term goals that have a high emotional appeal. This seems to set these funds apart from the rest.

Moreover, the inherent asset allocation of these funds is an added advantage. By investing in these funds, you likely won't need to worry about allocating your corpus between equity and debt, nor will you need to concern yourself with periodic rebalancing. The mandatory lock-in period of these funds can also prevent impulsive withdrawals during market corrections, which can be especially beneficial for investors who tend to panic when the markets fluctuate.

The longer investment horizon allows the fund to take advantage of market fluctuations and potentially generate higher returns compared to more conservative options.

Last but not least, some investors might find it psychologically more appealing to invest in these funds, preferring that the money remains locked in until it is needed. Such investors can also consider these funds.

When you choose to invest in solution-oriented schemes, it’s like selecting a path specifically designed to meet your needs. However, every path has its challenges, and it's essential to be aware of these before beginning your journey. Here’s a simplified overview of what you might encounter with solution-oriented mutual funds.

1. Missed Opportunities: Since these funds typically invest in large cap companies, you might miss the opportunity to invest in other categories such as small and mid caps that have the potential for significant growth.

2. Five-Year Lock-in: Often, when you invest in solution-oriented mutual funds, your money is tied up for five years. This is because these funds typically don’t allow you to take your money out before this period is up. If the performance of a scheme lags, the investor cannot switch to another scheme in between the investment period.

3. Market Sensitivity: The value of your investment can go up and down due to market trends, something you need to be prepared for when investing in solution-oriented schemes.

When selecting a retirement fund or children’s fund, consider which variant aligns with your requirements. In the case of retirement funds, if you're in the accumulation phase, the equity or aggressive hybrid variant may be more suitable. However, if retirement is imminent in the next few years, the more conservative debt-tilted variant would likely be a better choice.

Conclusion:

Solution-oriented funds provide a strategic way to achieve specific financial needs through disciplined investing and professional management. They offer a structured approach to saving for retirement, children’s education, or marriage, making them an attractive option for need based investing. However, like any investment, they require careful consideration of one’s financial situation, needs, and risk tolerance to ensure they align with the investor's overall financial plan.

Everyone wants to invest in the best-performing asset class every year. But, the thing is, it is nearly impossible to choose the best asset class consistently. That’s why diversification is key. 

Harry Markowitz rightly said that “diversification is the only free lunch in investing”. This is the notion that holding a broader range of assets can result in reducing the overall risk and increase the likelihood of achieving more stable and consistent returns over time.

Diversification is a vital concept widely accepted by many investors across borders. It is an important tool to help investors achieve the proper balance between return and risk for their situation. Crafting a diversified portfolio requires a blend of asset classes tailored on the basis of one’s risk profile, financial goals, and investment horizon. This is where asset allocation comes in. 

Asset allocation is a strategy that involves distributing the portfolio’s investment into different asset classes, such as equity, debt, cash, real estate, etc. Let’s look at the important factors for the right asset allocation mix:

• Investment Objective - The choice of asset allocation is heavily influenced by the particular financial objective that an investor seeks to fulfil. Aspirations can be very different, ranging from short-term goals like saving for a down payment on a home to long-term ones like building wealth for retirement. Different investment strategies and asset allocations are needed to achieve different goals. For instance, you might devote a bigger percentage of your portfolio to equity if your main goal is to create wealth in the long run.

• Risk profile - Before choosing the asset allocation, determining the risk profile is of utmost importance. An investor should define his risk tolerance, i.e. his willingness to withstand market volatility and the level of risk he can comfortably bear. The investor must then define his risk capacity, i.e. the capacity to absorb potential losses. By identifying the risk tolerance and the risk capacity, an investor can form his risk profile based on which he can allocate his investment to different asset classes. 

• Taxation - Different asset classes have different tax implications. Understanding the tax efficiency of different asset classes can have an impact on the post-tax return. For instance, dividends and capital gains of different asset classes can be taxed differently. By understanding the tax implications, an investor can efficiently plan and manage his investments. 

• Goal maturity - The time horizon remaining for different financial goals must be considered before making any asset allocation decision. When you are a few years away from your financial goal, your portfolio is considered to be in the transition stage. Most experts suggest you should move towards an asset allocation that is weighted more heavily towards low risk assets like bonds than stocks.

• Age - Typically, younger investors with a longer investment horizon may have the capacity to withstand short-term fluctuations and may opt for a more aggressive asset allocation that includes a higher proportion of equities. However, as an investor approaches retirement age, it would be wiser to follow a more conservative asset allocation. 

Now, let us look at the performance of different asset classes.

Source: Property: https://residex.nhbonline.org.in/ (Composite HPI for 50 Cities), Bonds: CRISIL Composite Bond Index, T- Bills: CRISIL 1 Year T-Bill Index, Gold and Silver: RBI Monthly Average Price of Gold and Silver in Mumbai, Sensex TRI: Ace MF

To judge the performance of an asset class, any investor’s go-to would be to look at its return on investment. However, data shows that every year, the winner amongst asset classes varies since the market is at the confluence of multiple variables. In the year Sep 2022-23, silver was the best performing asset, however, in the years Sep 2021-22 and 2020-21, silver has given negative returns. Similarly, different asset classes have performed differently in different market phases. So, investors should create a well-diversified portfolio in which their money is spread across a range of asset classes in accordance with their investment objective and risk profile.

Conclusion:

The quest for an optimal asset allocation must be based on the factors above rather than just picking top performers. Equity can provide long-term growth, and the stability of debt and gold can help safeguard the capital for the long term. Choosing the right asset allocation may seem like a challenging task, and hence, an investor should opt for the guidance of a financial advisor who can help investors make informed decisions.