Wholesale follies of retail investors

A young couple came to see me recently to seek advice on their investment. The lady is working in a private firm and the gentleman had returned from West Asia and is in the process of setting up a business. Lured by the stories of attractive returns from the stock market they invested around Rs 10 lakhs in stocks in mid 2016. In almost 2 years they had lost around 35 percent of their investment in this booming market, which saw Nifty appreciating by 35 percent. They came to seek my help to set their portfolio right.

Having known first-time retail investors’ behaviour for 3 decades, I was not surprised by their portfolio.  It was a collection of low-grade stocks. Among 12 stocks in the portfolio there was only one stock that was investment grade. The rest were low-grade small caps. When I asked them why they bought such low-priced stocks and completely avoided blue chips the answer was “high priced stocks are risky; low-priced stocks have the potential to appreciate faster.” Had this young couple invested in a good mutual fund or an ETF they would be sitting on good profits now. But the ‘confidence’ that they have the ability to choose stocks and the mind-block that high-priced stocks are risky led them to disastrous investment that resulted in huge losses in a bull market.

Some of the best performing stocks in India in recent times have been 5 digit stocks like MRF, Eicher Motors and Page Industries. But most retail investors have been intimidated by the high price of these and other high-priced blue chips.

Many retail investors do not have the time or expertise to directly invest in stocks successfully. For such investors, it would be better to invest in equity through SIPs. SIPs have given excellent returns in the long run. Study of equity- diversified funds with a history of more than 10 years has shown that there is 94 percent chance of positive returns in 4 year SIPs, 90 percent chance of positive returns in 3 year SIPs and 84 percent chance of positive returns even in 2 year SIPs. As the time horizon extends, the probability of high returns increases substantially.Of course, returns depend on the choice of fund and the scheme. For instance,if we take the performance of equity fund SIPs in the last 20 years (from September 1997 to August 2017), we can see wide divergence in performance. The best fund has delivered a CAGR of 25.14 percent while the worst performing fund delivered only 11.38 percent CAGR. During the 20-year period from1997 September to 2017 August, 20 funds have delivered CAGR of more than 15 percent.It is important to appreciate the fact that during this 20-year period, the worst performing equity mutual fund delivered an annualized CAGR of 11.38 percent, which is far superior to the returns from gold and bank FDs during this period.

In brief, for investors who don’t have expertise and time to invest in stocks directly, Systematic Investment Plans in mutual funds is the ideal choice.