Liking something can be dangerous too

In the famous book, Influence by Robert Cialdini, liking is one of the reasons for getting influenced or acting irrationally.

Liking for someone, we careful

During the pandemic time, a lot of people started ordering from Zomato. In a few months, the company came up with an IPO. A lot of people associated liking ordering from Zomato to holding investments in Zomato.

A mere association with a company’s product/service led to positive signals about the IPO. Ideally, someone who wanted to invest in Zomato should have studied the company, performance, plans etc.

Common background

Imagine you get a message to connect over LinkedIn. Assuming the invite is from someone who has a similar background as you, the probability of establishing the connection is a lot higher. There is a general liking for that person.

You may not even look at the invite if it comes from someone who is not from your city and whose educational background does not match yours.

Listening

In the book, How to Win Friends and Influence People by Dale Carnegie, it is mentioned that you can influence people by just listening.

A salesperson is most effective when they listen to customers. Similarly, a financial advisor will be able to win a client if he/she just listens to them. People want to share, and they need an outlet for someone to listen. People who listen are LIKED by everyone.  

You can massively increase your odds of being in the good books of others by just ‘listening’ to them.  

Boring industries are disliked.

There are so many companies in rather boring industries. The share price of those companies even during a bull run is reasonable. One of the reasons is that people in general don’t like them. In the short-term, prices don’t move that much but in the long-term share price catches up with the fundamental performance.

You increase your chances of investment success by just associating yourself with boring things/industries. People in general don’t like boring industries and that will ensure you get a reasonable purchase price.

Narratives

Be very aware of how media plays with your mind. A certain narrative can have a massive influence on your mind. For example, when Hamas attacked Israel, pro-Israel sentiments prevailed, and when Israel started bombing, pro-Palestine sentiments prevailed.

Rather than sharing facts, opinions are planted, and people are managed by media houses all over the world. Unless I am aware of the facts of Israel/Palestine, Ukraine/Russia etc. how can I have my opinion? I need facts for my assessment, but the media is only interested in sharing opinions.

Expert opinions

A lot of finance experts come on TV channels to share their opinions (shown as facts). Better language skills and charisma can add to your liking for the finance expert, and you can indirectly develop a liking towards the opinion of the finance expert.

It is a different matter that often these finance experts have their agendas to be on TV. Maybe their suggestion of an investment product is driven by the wrong incentives by the product manufacturer.

Similarly, a stock name shared by the finance expert can influence you to act on it without doing your analysis.

There is no harm in getting influenced through liking for someone. However, the decision should not be based on the liking of the product or a person. Rather, it should be on its own merit and unbiased analysis. Not an easy task though.

The power of ‘incentives’

The power of incentive is so strong that even the best in the field gets trapped. Let’s start with a simple yet popular slogan these days “mutual funds sahi hai”. You must be wondering, if Sachin and Mahi promoting mutual fund investment, it must be right only.

Real estate boom is the current theme

Well, their incentive to promote mutual fund investment is because AMFI pays them a fee.

You want to grow your wealth, but you don’t know where to start.

There are so many mutual funds and a handful worth looking at, you get confused. You take advice from the first available person, say your banker.

Your banker is incentivised for any sales he/she does on financial products. You will be lucky to be sold a below-average mutual fund, often the incentives are more for bankers to sell insurance products or structured products.

Even if your banker is an ethical person, he/she may not be able to take a fair stand. For example, in an upward-moving market, a lot of good funds will look like average. Your banker will have a hard time convincing you to allocate to good schemes but have current ‘average’ performance.

He/she will save time (incentive) and recommend a top-rated scheme with high performance but in a few months, this scheme will become an underperformer. In a bull run, the worst fund managers are often celebrated. Even you will be more convinced with top-rated fund managers due to the comfort of not thinking (incentive) too much.

After a few months, you will realize that your banker is incentivised and is not recommending anything for your benefit. You will look out for a personal financial advisor. Interestingly, even for a financial advisor, the incentive to take a contrarian stand may be tough.

Just imagine, it is courageous to recommend investors to allocate when the markets are falling. Similarly, it is not good business sense to discourage more investments when the markets are overheated. An ethical financial advisor will do just that.

If you have an incentive to grow your wealth, you will educate yourself with the tools including how to evaluate management, financial advisors, investment products etc. You will then appreciate investment professionals who can make contrarian decisions.

Often the incentives of people involved in a certain sector increase when the sector is overheated. Infrastructure funds were launched in 2007/08, but the return is still negative. Post covid, manufacturing funds and real estate-focused investments are being launched.

It is much easier for the fund houses to launch hot themes. They don’t have to push for the sales, it will sell on its own. Just give a high incentive to the distributor, the launch will be massively successful for the fund house.

However, the experience of investors may not be pleasant. Financial advisors or distributors should be saying for these schemes ‘ye mutual fund sahi nahi hai’.

People with misaligned incentives will be quite nice to talk to especially when they have to sell something or source something from you. You need to switch on your System 2 thinking and figure out the incentive.

We are surrounded by people with misaligned incentives. Right from a celebrity trying to sell a fairness cream to an investment product to things that we don’t need.

Incentives are not just restricted to money but spread to all aspects of human life. You reflect and you decide for yourself.   

Investing in Mutual Funds

There are hundreds of schemes across different categories of mutual funds. It is hard for an investor to identify which scheme is better. It is not about the highest returns; it is about a scheme or combination of schemes that will help in achieving an investor's financial objective. In this article, we will explore a lot of information from knowing the basics to creating investment portfolios using mutual funds.

Investing in Mutual Funds

What are mutual funds?

A mutual fund is a pool of funds from many investors that is used by a fund manager to meet a certain investment objective.

Are mutual funds safe?

The next question investor often has is whether mutual funds are safe. During the 90s when the Harshad Mehta scam happened followed by US 64 disaster, a whole generation lost faith in the equity market.

A lot of cleaning has been done in the last three decades. The equity market regulator, SEBI has progressively made mutual fund investments safe for the investor.

SEBI understands that Indian investors are not financially savvy. All the regulations related to mutual funds can be categorised as biased towards retail investors. Regulations cannot protect the movement of the market; an investor must guard himself or herself against any market movement. You cannot blame the regulator for a general decline in markets and the erosion of investment portfolios. You have to do your homework, anyways.

Types of mutual funds

In India, mutual funds are available in three categories i.e., debt, equity, and gold. Soon we may be looking at the fourth category, real estate in the form of real estate investment trusts (REITs).

1. Debt funds are for income; in simple terms, you can see them as a substitute for your fixed deposit.

2. Equity funds are used for long-term investing.

3. Gold provides a good hedge against inflation.

There are many debt instruments in India including provident fund, PPF fixed deposit, NSE and others. The benefit of investing in a debt mutual fund is firstly liquidity. A lot of government-sponsored debt instruments including provident funds are not liquid. Another benefit of debt mutual funds is the diversification benefit. Investing in one debt mutual fund gives you access to a broad range of bonds across different sectors, including government bonds.

There are many types of debt mutual funds. Broadly they are classified across four categories.

1. The first category is a liquid fund. A liquid fund invests in corporate deposits and government treasuries. Across all categories, the liquid fund is the least volatile.

2. The other categories include ultra-short-term debt funds and short-term debt funds. These funds invest in corporate debt and government debt maturing in 1 to 3 years. When RBI makes changes, liquid funds will be the least impacted.

3. The next category is medium and long-term debt funds. As the name suggests these funds invest in medium-duration and long-term duration i.e., more than five years of maturity. When RBI makes changes to the interest rate, these funds are severely impacted.

4. The last one is the arbitrage fund. Although arbitrage funds are equity funds they behave like liquid funds. Since these are equity category funds, taxation of equity is applied i.e., in the short-term 15% and in the long-term 10%. This category would be the most tax efficient for people in high tax brackets.

There is an inverse relationship between interest rates and the duration of a mutual fund. A medium and long-term debt fund will fluctuate a lot when there is interest rate movement. A lot of retired people who want to create cash flows based on their retirement needs may evaluate medium and long-term debt funds.

Let’s discuss the equity category now.

There are broadly four categories of equity mutual funds. The other categories such as thematic, small and mid, large, and mid etc. are just slices and dice of these categories.

Large-cap funds

Large-cap funds invest in the top hundred companies by market capitalisation in India. There is a lot of debate that index funds are better in this category than actively managed funds. An index fund as the name suggests is passively managed and there is no fund manager whereas an actively managed fund has a fund manager and thus a higher fee is applicable.

Midcap funds

These funds invest in the top hundred to 250 companies by market capitalisation. In this category, a fund manager has a crucial role. This is the reason performance within the Midcap category can be very wide. Wrong selection in this category can be very costly to the investor.

Small-cap funds

These funds invest in the top 250 to 500 companies by market capitalisation. In this category also a fund manager’s role is critical. Relying on index funds can backfire.

Multi-cap category

These funds invest across categories irrespective of the market capitalisation which is a combination of large-cap, mid-cap and small-cap.

Indian mutual fund industry offers debt, equity, and gold mutual funds. What should be the combination across all these for the investor? Should the debt be high, or Equity be high? what about gold?

You need to know whether you are an aggressive, moderate, or conservative investor.

Do not assume that if you are earning well, you are aggressive, and do not assume that if you are not earning well, you are conservative.

You must reflect on your risk profile from two perspectives. One has your level of income and asset base and on the other side your comfort with volatility.

An aggressive investor is a long-term investor and very comfortable with volatility. Similarly, a moderate investor is a long-term investor but is not too comfortable with volatility. A conservative investor is an investor with an extremely low level of comfort with portfolio volatility.

Plan first

The first task you need to perform is to identify your investment objective also called financial goals. This will help you understand the time horizon that you have to invest in.

Retirement could be a long-term goal say 15-20 years from now, whereas buying a car could be a short-term goal. Once you have identified your goals and time horizon, you will have clarity in terms of which mutual fund to select.

Based on your risk profile and your investment objective, a combination of equity, debt and gold can be selected. A conservative investor can have a minimum investment of 25% into equity and 75% in combination with debt and gold. This changes to 75% in equity and 25% in debt and gold for an aggressive investor.

This is a broad guideline and not an answer; even if you are an aggressive investor, but you have a short-term goal, say you’re retiring in the next five years, you should not invest 75% in equity. Similarly, if you are a conservative investor, and you have a long time to achieve your objective, you should not shy away from not investing in equity.

‘Mutual funds Sahi Hai’ is only for those people who partner with the right fund managers. A careful assessment to select the right fund managers is key to ‘mutual fund Sahi Hai’.

At monthlysip.com, we use our proprietary models to identify mutual funds across various categories. We reach out to the fund managers and study the underlying assets of funds to understand whether the fund's inclusion is appropriate for the investors.