Having an investment plan, even an unsuitable one to begin with, is better than just haphazardly buying whatever someone is selling to you
11-Oct-2019 •Dhirendra Kumar
Have you ever been in a house built without an architect or a plan? Such houses used to be common in small towns in India, and perhaps they still are. Someone would buy a plot of land, hire some construction labour and set them on the task. Instead of a plan, the owner would wave his hand and ask for one room here and two rooms there and maybe a bathroom there. When half the house was built, he would ask for an extra bathroom to be inserted somewhere. Maybe a staircase to go to the roof. Maybe a wider gate because someday a car may be bought. The bathroom would have a ventilator opening into a room. The staircase would have oddly tall steps tapered at one corner. One wall would be thinner than the rest. And so on.
Maybe such houses are still built, or maybe they are not. However, investment portfolios that resemble such houses are very much the default. Actually, I'm probably being unfair to the houses. Most of us tend to have haphazardly-grown sets of investments that can hardly be called a portfolio. However, the house at least serves the purpose of the owner. By contrast, far too many investment portfolios are artifacts produced by whatever was being sold aggressively at various points and a result of how persuasive the salespersons were.
Even so, one can't really fault the salesperson - their job is to make money for their employers while our investments are our responsibility. So why would you buy a particular investment? There are two kinds of mental processes that lead us to buy something. In one, we have a need for something, and the need to satisfy that need is the driver. In the other, we see something and invent a desire in order to justify the purchase. Most decisions are a combination of the two, but investment decisions shouldn't be.
Here's how it normally works. Let's say you feel the need to own a television set because you'd like to watch all the wonderfully entertaining, informative and tasteful programming that's there on TV. Once you've decided that you do need a TV, the desire-creators take over: 32 inches? 42 is better, 56 even more. HD is just the basic, it must be 4K. And obviously your TV must be smart, smart enough to watch you and listen to you and transmit all that data to someone on the internet.
Or you could start at a different point. You already have a TV and find the programming neither entertaining, informative nor tasteful. However, the ads make you feel that it's time to buy a new TV that can do some tricks that the old one can't, you're willing to junk the old one.
Unfortunately, the selling and buying of investment products follows the second model rather than the first one. Ideally, the starting point would be that you realise that you need to invest for some specific needs. Then, you would choose what type of investments fits your needs best. And then you'd go ahead and invest in the ones you have chosen.
For example, you need to save up for a big expense that's perhaps a decade in the future. The money that you'll save for this expense is not a big part of your net worth and the period is long, so investing in an all-equity fund is the best way to go. Having decided this, you should look at the track record of all diversified equity funds and choose a small number, perhaps two or three that have a good long-term performance. Then, you should start investing gradually an equal amount in all of them.
Now compare this ideal method to the more prevalent 'consumer goods' style of choosing an investment. You see an ad (or otherwise come to know about) for a mutual fund with a particular set of features. You see an ad or listen to a convincing story about how this or that feature-set or theme makes sense. You get worried that your investments don't have that feature. And so you believe the story and invest in the fund.
The difference between the two types of decision making couldn't be more stark. One starts with your own real needs and the other starts with an artificial need that serves someone else's commercial purpose only. However, when you pause and think of your investments in a careful, step-by-step way, then it isn't difficult to make the right choice the right way.