12 August 2014

"What to do with money?"

OK, you managed to save some money. Feel like an investor?

What do you do?
  1. Stay away from wealth managers. In the end, all they achieve is to make your savings work for them. If any wealth manager persists in chasing you, ask him two questions:  (a) Does his fee depend on the increase in your wealth? Or on the number of transactions he executes for you? (b) Can he explain what are "alpha", "beta" and "r squared" in portfolio theory? What has been his "alpha" last three years?  Most would run away by this time
  2. Stay away from hedge funds. Yes, you read about several billionaire hedge fund managers. You have seen their yachts. Have you seen their clients' yachts? Understand two facts: One in a thousand hedge fund managers makes profit by predicting a "tail end event" well. Two, no hedge fund manager has predicted two "tail end events" well. Your dilemma: If you join a star hedge fund manager, odds are against you making money. If you join a yet to be star fund manager, odds are against you making money. You still want to go with hedge funds? Read "When Genius Failed" before you do.
  3. Stay away from technical chart makers. Run away from anyone who talks about candlesticks. Technical advisors presume that the past is a good indication of future. Remember Eastman Kodak in photography industry? Remember Lotus 1 2 3 as a spreadsheet?
  4. Resist the temptation to pick individual stocks. Resist the temptation to study the alpha (superior performance of an individual stock over risk adjusted return of a benchmark) and beta (correlation between volatility of stock and volatilty of market). Sharpe got his Nobel prize for this theory. Shiller, another Nobel laureate, discredited Sharpe's theory. As far as you are concerned, invest in businesses, not in stocks. If you think a company's business has a great future, go ahead. If you think a company's business model sounds suspect, stay away.
  5. Do not believe you can predict stock prices next week. With some luck, you can predict the long term trend of a stock price. There is no way you can predict what the stock price is going to be next week. That is more likely to be swayed by sentiments in the economy and sentiments in the market (that you cannot predict) or inside information (which can make you rich until regulators catch you and put you in Lavenworth maximum security; food, am told is not very good).
  6. Do not believe debt is safe. The price of debt varies inversely with interest rate. If the Fed increases interest rate, your asset value would come down proportionately (unless you have short maturity paper). Are you comfortable you can predict how Raghuram Rajan is going to behave next week? Understand that debt has its own risk.
  7. Do not believe anyone offering above market returns. They cannot. Not unless what they do is illegal or they plan to do the old trick of using the next guy's investment to provide you superior return so that they can attract the third guy to make an investment into their fund. Google "Ponzi" for more details. This was Boston's contribution to financial world more perfected by several benefit funds in Chennai.
  8. Do not believe Gold is a safe asset class. Gold gets you a warm hug from the wife. That is pretty much about it. Gold is just one more asset class with its own risk and volatility.
  9. Do not believe fixed deposit is therefore the better thing to do. Fixed deposits are constantly eroded by inflation. When you deposited, you could have bought ten bananas with the money. When you get it back with interest, unless the interest compensated for inflation, you can buy less than ten bananas. Interest rates have not been compensating for inflation.
  10. If you are in the US, do not believe you can make money by earning more interest in India than in the US. There is a reason why interest rates are high in India (remember, inflation?). Inflation has an unavoidable impact on currency rates. By the time your deposit matures, you may have more rupees translating to less dollars and you are, if market works to mathematics, back to square one.
  11. Do not invest any money that you may need in the next year or two. Keep that in cash. Market has its short term ups and downs. The day you want to encash your investment could be one of those "down" days!
What, therefore, can you do?

Invest in exchange traded index funds. (Translation: You are investing in all the stocks that go into the index. In other words, in the entire market). An equity index and a debt index. More equity if you are young. Less equity if you are old.

After you do this, do not bother tracking your wealth on a daily basis. Leave if for a few years. Investment in securities is a long term business. Plus, there are better things to do in life than wearing anxiety over the movement in your wealth on a daily basis.

Baaki advice sub bakwas.

(Oh, btw, my lawyers want you to know you are on your own, and am not responsible for any losses you suffer. In spite of this if you believe I am the cause for any profits and therefore you want to share them with me, do call me. I will send you the wiring instructions!).


Partha Sawardekar said...

Some good advices there, yet I wonder how anyone can simply generalise all these money making instruments as 'good' & 'bad' products.
I believe, successful/profitable investments, if anything, are the function of only ONE crucial factor: Timing!
Investment in a 'bad product' (as per above list, e.g. gold), if done with good timing, can make you a heap of money. And vice versa.
Footnote: It's not only about timing your 'buy' well, it's equally important to know when's the best time to sell out (a lesson I've personally learnt the hard way many times).

T R Santhanakrishnan said...
This comment has been removed by the author.
T R Santhanakrishnan said...

Thanks for the comment, Partha. Appreciate your visiting my blog.

Investing in market (all equities and all debts) through index funds is on an average a better strategy than cherry picking individual stocks or bonds because it gets you the advantage of "minimizing" the beta to 1 though you suffer by "reduction" of alpha to 0%. If you are not an expert investor this is a safer route. Studies have shown that the index has outperformed focused funds over a long term.

Can this guarantee maximum return? Certainly not. You can always get more by getting into a star performer at the right time and getting out at the right time. Two problems: You need to identify a star performer. You need to identify the time to enter/exit. If you can do that, awesome. My observation is for people who cannot.

Read Warren Buffet's statement that his one recommendation to his wife is that she should invest in an index fund and relax instead of bothering about individual stocks. That comes from an individual who spent all his life in cherry picking stocks.

Swarnalatha R said...

ha ha.. you left out the simplest: Donate to the deserving or the needy or to a worthy cause and earn.... goodwill :)

Sriraman Ranganathan said...

Very good inputs TRS. Pretty interesting to read.