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Hindsight Bias – Did you know it already?

Investor Psycology

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November 2, 2017

Hindsight Bias – Did you know it already?

Hindsight bias is a behavioral trait in many of us. It is a sense that you knew a particular incident would happen after it has happened. You feel that you had predicted the incident. It may not be accurate as you might have thought of different outcomes but once a particular outcome takes place, you tend to remember that one and forget the other possible outcomes.

This trait can lead to overconfidence and inaccurate estimation of events and their probabilities.

You can also get Simple But Most Powerful Tool To Avoid Investment Biases from the bottom of this post.

Common examples of hindsight bias –

If you see clouds getting thick and grey, you might think different things – ‘it might rain’, ‘it will rain’ or ‘the cloud cover will pass on’. But if it rains sometime later, you will believe that you knew it will rain.
It is the finals of the IPL tournament and your favourite team is playing. If it is an equally contested match, you will think of different possibilities – ‘Your team wins’, ‘Your team loses’, ‘It can end up being a draw due to rains’. But if your team wins, you will feel that you predicted correctly that they will win.
Similarly, you buy a stock and the price falls, you think that you just knew it that it would fall. On the other hand, if you make handsome profits, you will feel proud that you made such an awesome decision.
And everyone knew that who will win the elections 🙂

Hindsight Bias – Did you know it already? Click to Tweet

Impact of Hindsight Bias on your Investments

Hindsight bias can lead negative effects on our investment behaviour and overall personal finances –

Overconfidence –

It can lead to overconfidence in our investment skills. If we pick some stocks or purchase some mutual fund schemes and they perform well, we believe that we have excellent investment skills. We only remember the instances when we were right and overlook the times when we were wrong. It might be that the factors that allowed us to predict correctly made the decision easy or obvious. This might lead to irrational and risky investment behaviour.

Look only for expected outcomes –

We tend to look for expected outcomes in any decision/action we take. We tend to remember only the big unexpected events. This results in not planning for the unexpected events. If we do not remember smaller events that affected our portfolio, we may not be managing the portfolio in the best manner. It is not possible to think of all possible outcomes but we have to be ready for unexpected outcomes. Believing that unpredictability is the norm will not have too many nasty surprises.

Mistaken analysis –

We tend to use memory rather than data and other factors to evaluate past decisions. This is a trap. It clouds our decision making. We remember the times our predictions were right and ignore the wrong ones. This can lead to irrational decisions regarding our finances.

Another mistake form of decision making is that if an event happens, we tend to look back and look for signs and pointers that proved that the event will happen. In hindsight, this might be easy, but at that time, there were many other factors and signs which would have made it difficult to predict.

How can we avoid hindsight bias –

Learn from the past –

We should learn from past mistakes – our mistakes made in the investment world. For example, when the technology bubble was busted in 1998, a lot of people said, ‘I knew it’ but very few of them had forecasted it. It is not easy to predict different scenarios. But we can learn from past performance of investment assets, market behaviour and our behaviour and decision making. Rather than focusing only on the right decisions, one should objectively evaluate all investment decisions – right and wrong.

Be aware of the influence of hindsight bias –

A majority of us have a hindsight bias. It is best to acknowledge it and then work around it so that we do not make wrong investment decisions. For example, if you have decided to buy a stock, do not look for reports and news articles that support your decision (this is confirmation bias). Search for reasons or news items that go into the decision. This will help in a more holistic investment decision.

Plan for the unexpected –

Expect the unexpected. Hope for the best but plan for the worst. We should hedge against negative events. It is a good idea to diversify the investment portfolio so that it is protected against unexpected negative outcomes. Focus on proper Asset Allocation.

Avoid being overconfident –

We tend to become overconfident when we feel that we have predicted events correctly. We follow the same pattern of decision making and somewhere down the line, we lose money. It is better to have a realistic view of our strengths and limitations. Look for performance indicators while making investment decisions. This helps in managing risk better and building a suitable investment portfolio.

Decide rationally –

Do your research thoroughly, understand the pros and cons of all investment decisions and actions and then choose the most appropriate one in your current situation rather than being swayed by past predictions.

Hindsight bias is a behavioral trait that can lead to problems in your investment portfolio. No one can be right all the time or wrong all the time. Objective evaluation is the best way to avoid such biases and make rational investment decisions.

Do you want to know – What is Simple But Most Powerful Tool To Avoid Investment Biases?

If you want to receive this powerful tool, all you need to do is to answer this simple question of mine:

Best financial advice that you have ever got?

Please, leave your answer – below – in the comment field.

You will receive the free PDF with Simple But Most Powerful Tool To Avoid Investment Biases.

Low Risk High Return Investment – is it possible?

Hemant Beniwal

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October 27, 2017

60

Low Risk High Return Investment – is it possible?

Today I want to do a SPRITE Ad in investment “Seedhi Baat no bakwas”. Low-Risk High Return Investment is a Mirage.

I get a chance to speak few prospects every week, a major change I have noticed is expectations are Sky High. Even the existing investors are getting carefree.

Everyone is singing in Chorus “Mauka Mauka”…

Don’t try to find hidden messages from this post because the equity market is “the great humiliator”. So do not try to predict market direction on the basis of what you think.

I am just trying to compare investor behavior today & a few years back.

A Journey from Disbelief to Optimism

Low-Risk High Return Investment is a Myths

Few major things that I have noticed – High, Higher, Highest:

Low Risk High Return Investment - is it possible? Click to Tweet

Returns– Kitna Deti Hai

Will you recall ad of Maruti “Kitna Deti Hai”? It’s not new that a prospect asks about returns in the first call. If that number was 1/4th earlier now it is 3/4^th – why such a huge jump. Everyone wants to peep for returns.

I think because clients are looking at past performance and they want confirmation that past can be mirrored in the future.

Last week when one prospect asked me what returns do you expect in the next 3 years, I said negative 30%. He said what?? I repeated negative 30% if you will be lucky & it can be even worse.

I keep saying this on TFL and even to our clients, we don’t have any idea about the market. We are very clear; we do not want to build relationships with wrong expectations.

Comparison in Portfolio Returns – Uski Shirt meri shirt se safed kaise

Return is one thing and higher returns are other. When markets are performing so well why someone would like to settle for less. If it’s low risk high return – it’s even better.

The comparison is a disease which keeps us away from happiness.

You gift a dress to your wife/girlfriend.

Reaction 1: This is really nice. Finally, your choices are getting smart!!!

Reaction 2: It’s good… I think… but… ok … will I look better than Ms. Pheku?

The happiness of gifting dies & even receiving. It puts pressure too.

Comparing your house with relative leads to buying a bigger house which you may not need. Comparison of car makes a big hole in your pocket.

Recently one prospect told me that he is not expecting higher returns, 15-18% is sufficient. I told him please manage my fund.

I don’t know from where people get all these numbers.One existing client said that one of his fund is not performing in comparison to the other, I told that’s good at least others are performing 🙂

Eager to Invest – Oh Yes Abhi

Eagerness is an emotion and emotion is psychological. I have observed that now everyone who knows even little about mutual funds want to be part of the equity market. They don’t want to miss some kind of Limited period sale.

To be frank such behavior is very dangerous for individual investors.

Recently a prospect called and he said he doesn’t want to create a plan (as it takes time) but directly want to invest his huge savings that are parked in SB Account in the equity market. (another asked about low risk high return Mutual Funds – Sahi Hai)

I said if you are 40 you have another 40-50 years of the investment horizon. What difference will one month make? If one month difference is bothering, you have already lost last 10-15 years.

Direct Stocks – Ye to bada toing hai

I think this advertisement is my second most hated adv – I think first is Car Trade where dogs are driving the car. But this ad catches my eye every time and reminds me of greed that investors surrender to. 🙁

Investors are not satisfied by market return. They’re not even satisfied by professional fund manager that still generating some Alpha. They feel that there is some secret sauce and Advisors will serve that in a paid buffet. They feel they can beat fund manager in their game when they are not even qualified and experience to play that. Debate on Mutual Fund Vs Direct Stock is not new.

I clearly remember 5 years back no prospect asked about direct stock – at least from us being a Financial Planner. These days I don’t remember if someone missed asking about that.

Recently one prospect also mentioned the name of one fancy stock and said that’s a bluechip stock and I want my portfolio to perform better than that. (Just to share that stock has gone up by 50 times in last 8-9 years)

I told him for god sake if I can generate that kind of returns, you would have never got a chance to talk to me. Claims on generating such returns are just hindsight bias – will share a detailed post on this.

You should remember this time it’s different is very dangerous statement – in last decade we have seen people getting disappointed in Real Estate & Gold due to higher expectations.

Risk – Taste the thunder

Will you take that kind of risk to have a single bottle of cold drink? If no it is important to understand what kind of risk you are taking to achieve some return.

If the return is real, the risk is also real.

But these days people are not willing to understand risk.

We regularly run fire drill exercise with our clients so they mentally prepare for future. We ask them how they will react if their portfolio will be down 40% next month.

Pain – Jor Ka Jhatka JOR Se Lage

Equities can give a lot of pain, it is important to understand risk and return relationship.

Black Mondays, Furry Fridays can happen anytime. The more you are near the fire, with nylon clothing, more you are prone to get 3^rddegree burns.

That is why the risk and returns need to be balanced. Don’t chase returns that too someone else has got. You are different and unique as per your risk readiness and returns expectation go.

The margin of safety is squeezing now. Alpha generation is a headache for fund managers. They are lowering cost to save returns. Greed is increasing, Times are changing…

Don’t waste time about thinking about Low Risk High Return Investment. Focus on your Goals & holding period. Don’t be worked up… let your PLAN work.

Feel free to share your views in the comment section. If you liked the post share with your friends.

Does Loss Aversion Affect My Finances? Nobel Laureate says YES

Investor Psycology

Hemant Beniwal

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October 11, 2017

6

Does Loss Aversion Affect My Finances? Nobel Laureate says YES

You must be wondering why I write so much on Behaviour Finance aka Investor Psychology. I firmly believe “Investing is not a Number Game it’s MIND GAME”. You will be happy to know that this year’s Nobel Prize in Economics Sciences went to Richard Thaler (Author of Misbehaving book) for his contribution to Behavioural Economics. Loss Aversion post is based on a concept introduced by Daniel Kahneman in his famous book Thinking Fast & Slow – he is also a Nobel Laureate.

Check what Loss Aversion is, how it affects your investments & what you can do?

Loss Aversion

It is a human tendency to avoid a loss as much as possible. A loss of Rs. 1000 gives us much more pain than the amount of joy we derive when we gain Rs.1000. Humans have a bias against loss and this has been proved in many behavioral studies. Loss aversion must be inbuilt in humans as in ancient times, being careless in hunting or an injury or getting excluded from the group could lead a human to die as the world was harsh. Therefore people who were cautious survived and we are their descendants. So evolution has made us such that we fear loss more than we like gain.

This post was tweeted by Paul Resnik – he is one of the best guys in Financial Planning industry who understand Investor Behaviour & Risk Profile.

Loss Aversion Examples

Few day-to-day examples – we are hesitant to sell a favorite old car or a piano even if it is not of much use to us now. If we are forced to sell it, we ask for a high price as we feel we are giving away something valuable and cannot bear to see it go.

Does Loss Aversion Affect My Finances? Nobel Laureate says YES Click to Tweet

Don’t we all get tempted by offers such as ‘Buy 2, Get 1 Free’ even though we might not need three! We want to take up the offer as we do not want to lose the one that is given free.

We are apprehensive of taking up a new role in the company we work in or change a job as we are in a comfortable place and do not want to risk it. Caution is good but being so cautious that we do not take up any risks or challenges will not help us achieve our goals or ambitions.

Read – Impact of Hindsight Bias on Your investments

How does Loss Aversion affect out personal finance?

Many of us do not sell loss-making investments hoping against hope that someday they might be profitable. This delay leads to further loss due to the erosion of the capital value.
On the other hand, we tend to sell off stocks whose prices are rising. We feel that if we do not sell them, prices might fall and we will end up making losses.
Many investors stay away from falling markets as they cannot digest losses. But when the markets come back to the true valuations, high-quality stocks & Mutual Funds would bounce back. People would have lost the chance to buy attractive stocks at low prices.
We invest maximum amount in safe, low-interest investment products that provide no great returns nor are able to beat inflation.

Check – Throwing Good Money after Bad

This behavior of averting losses leads to reduced gains.

How we can avoid losses due to this kind of behavior –

1) Do not check your portfolio on a daily basis –

It is not necessary to check your investment portfolio on a daily basis as it is supposed to be based on a long-term view. If you check it daily, you may get disappointed when your portfolio shows a loss or a lesser profit than the previous time you checked. This may lead to actions based on panic and emotion which may not be in the best interests of your financial health. It is better to check the portfolio less frequently as you will see very few instances of losses.

Check – Effect of Holding Period on Returns and Risk

2) Think logically –

When you want to invest in a product or sell off a product or change your job or buy something of significant value, think of these points –

Why should you do it?
Why should you not do it?
What are the risks involved?

List out the pros and cons. This will help you in reaching a rational decision.

Read – The Art of Thinking Clearly

3) Turn around loss aversion as an advantage –

Loss aversion is good up to an extent. It prevents you from making mistakes. It helps in making you think about various aspects of a decision. You can use it to your advantage. When you decide not to buy an investment product and its price goes down over a period of time, remember it and congratulate yourself for the right decision. When the markets are volatile, and you do not react but wait for them to stabilize, remember to pat yourself on the back. Mark out the days when you took a positive action. You will feel motivated to mark out all days as a day with no marks will disappoint you and push you to do something positive. It can be anything – going for the morning walk, learning to swim or taking a step towards building your financial portfolio.

Our investment behavior is influenced by many behavioral aspects and loss aversion is one of them. We should work towards managing it so that we do not err in decisions related to our financial health. What you can learn from well-Behaved Investor

If you like this articles must share with your friends. Also, add your experience in the comment section.

DSP BlackRock Equal Nifty 50 Fund Review

Mutual Fund

Hemant Beniwal

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October 2, 2017

23

DSP BlackRock Equal Nifty 50 Fund Review

DSP BlackRock Mutual Fund has launched the DSP BlackRock Equal Nifty 50 Fund, its first scheme in the passive fund’s category. If your question was “how to invest in nifty 50 equal weight index?” – DSP is the answer but still, there are many questions which are unanswered.

You can check how it’s different from a normal index fund, key features, DSP presentation, similar product, pros / cons, a lot of data & my views.

Image courtesy of Danilo Rizzuti at FreeDigitalPhotos.net

Index Fund Vs DSP Equal Weight Index Fund

An Index fund is a mutual fund scheme where the portfolio is such that it matches the constituents of a popular market index like the Sensex or Nifty. The weight given to different constituents is more or less the same as the market capitalization of the index constituents.

Check – DSP Healthcare Fund

An equal weighted index fund invests in the same constituents as the index it is based on but the amount is invested as equally as possible across all the companies.

For example, HDFC Bank and Kotak Mahindra Bank are part of Nifty. HDFC Bank has a weightage of more than 9% and Kotak Mahindra Bank has about 3.5% in the Nifty. So if you invest in an index fund, 9% of your investment will be allocated to HDFC Bank and 3.5% to Kotak Mahindra Bank. But in an

But in an equal weighted fund, the manager will allocate an equal amount of your investment money in both stocks. So HDFC & Kotak will get 2% each.

DSP BlackRock Equal Nifty 50 Fund Review Click to Tweet

DSP BlackRock Equal Nifty 50 Fund

This fund will invest in stocks that compose the Nifty 50 Equal Weight Index in the same proportion as the investments are done in the index.

Investment Objective of DSP Index Fund

Invest in companies that are part of NIFTY 50 Equal Weight Index in the same proportion as in the index. So 50 Stocks will get 2% each.
Generate returns that are on par with the underlying index – after fees and charges. The expense will be less than 1% – Index funds have much lower cost in comparison to active funds.
In the quarterly balancing strategy, the fund will ensure minimising risk by selling out performers at a high and buying underperforming stocks.

Key Features of DSP Equal Weight Index Fund

The fund has a diversified portfolio as it invests in 50 companies. 95% of the funds are invested in Nifty Equal Weight Index stocks and 5% in debt and debt related investments.
All the companies that comprise the index are large-cap stocks. So you can have exposure to large cap equity by investing in this fund.
Since allocation is equal across stocks, there is no fund manager bias etc. that will affect your portfolio.
You have to invest only a minimum of Rs. 1000 & there is no exit load.
Management fees and expenses should be expected around 1%.
The scheme’s performance will be benchmarked against NIFTY 50 Equal Weight Index. The fund manager is Gauri Sekaria.

Dsp black rock equal nifty 50 fund presentation

Should You invest in DSP BlackRock Equal Nifty 50 Fund

I was not able to get raw data so I am depending on other sources including NSE & DSP.

Note: DSP Mutual Fund Shared some clarification – you can check that at the end of this post.

Returns – It is an Equal Weighted Index fund & it tries to generate higher returns than normal Index within the framework of passive management as it is a kind of smart beta passive fund. This is done as it will follow the quarterly rebalancing method where profit booking will be done at regular intervals. (at least fund management want to give this impression)

I got this data from NSE website – if you look at the simple return table (3 year & 5 year CAGR), Nifty50 equal weight returns in this period are lower than a normal Nifty 50 index. I am not sure why DSP did not share normal performance table in their presentation. Long term difference is pretty impressive.

Similar Product – DSP BlackRock Equal Nifty 50 Fund is not first equal weight fund index. Sundaram Smart NIFTY 100 Equal Weight Fund (ETF) is a similar product but their index is even broader Nifty 100. My understanding is Equal Weight strategy works better in a broader index – that gives you chance to capture the growth of a particular stock. But Nifty 100 is not a pure large cap – you can consider it multicap.

Expense Ratio – Biggest benefit of an index fund is lower cost, the expense ratio is lower than active Mutual Fund schemes. On the other hand, it is not clear as to why there should be management fees as it just follows the index that it is based on. If there is active churning for rebalancing of stocks, then the fees would be higher compared to other passive funds. This defeats the purpose of it being an index fund – if we are just looking at the cost.But even 1% is higher for index funds like DSP Equal Nifty – Sundaram is charging 1.5% for ETF. There can be 2 major reasons –

Even 1% is higher for index funds like DSP Equal Nifty – Sundaram is charging 1.5% for ETF. There can be 2 major reasons –

Asset size – Indian investors are not investing in passive funds. Sundaram was launched in Jan 17, still sitting on 20 Cr AUM.
Higher Churning – due to quarterly rebalancing & product mandate.

Diversification – An equal weighted index fund will take care of situations such as a change in weight of stocks in the fund, performance of stocks and mean reversion. Today the banking sector has the highest weightage in Nifty. In the near future, it might be different. Moreover, same stocks and sectors do not always perform well. They move towards the mean price. In such cases, you will lose out if you have too much exposure to one stock or sector.

Top 10 Stocks in Nifty 50 Means – 50% allocation. Equal weight scores better in diversification.

Sector Weight – Nifty 50 Vs Nifty Equal 50

Active Vs Passive – Equal Weight Strategy stands somewhere between pure active & pure passive. In India, usually, the actively managed funds perform better than Index funds. So people do not invest too much in index funds but I can visualize that will soon change. As more investors flock to mutual funds – it will be tough for fund managers to generate Alpha. Mutual Funds will not like this statement but it’s true – Alpha Gone Index On 🙂

~~Misleading Data~~ – DSP is highlighting that the Nifty 50 Equal Weight Index has outperformed Nifty in 11 out of 17 calendar years (Source: DSP Mutual Fund – Slide 6).

NSE Site – you can check entire report here

“On a (fiscal) year on year basis, however, the performance of equal weight index strategy is more balanced. Of the 21 complete fiscal years since inception (from 1996 to 2017), the equal weight index strategy has outperformed its market cap weighted variant for only slightly over half the number of years (11 to be precise). This serves as a reminder that much celebrated equal weighted strategy may not consistently outshine other strategies.”

Torture Numbers – I keep saying that you torture numbers & they confess to anything. DSP is using data since 2000 (calendar year) & NSE since 1997 (financial year). It’s not about DSP – every AMC lie with statistics. If you look at slide 7 – where DSP claims “Investments for 5 year periods delivered POSITIVE returns 100% times”

If you look at slide 7 – where DSP claims “Investments for 5 year periods delivered POSITIVE returns 100% times” – that statement may be right based on the data they have shown but 17 years is very short to prove anything. This is like saying “I suggested you a stock which is up 5% in last 1 month – that means I can generate 60% CAGR returns for you”.

Falling Market Vs Rising Market – I don’t have sufficient data to say this on Indian Index but in Rising Market Equal Weight index will outperform market cap weight index. But in falling market – equal weight index may see more drawdown.

My View –

Future is passive so we should add such funds in our watchlist. Equal Weight Index funds will be more consistent than active funds – will be really helpful in building retirement strategies including Systematic Withdrawal Plan.

If you want diversification, exposure to large caps and do not mind paying a little more fee as compared to other index funds, you can invest a part of your equity allocation in equal weight index fund. On the other hand, if you are a seasoned investor, willing to take higher risks and believe you can do better with active funds, you can continue with the existing portfolio.

Normally we suggest that investors should not invest in NFOs but this is an index fund & we have to judge this based on our conviction about such products.

Clarification by DSP Mutual Fund on my observations

Disclosure: A few months back a small group of SEBI Registered Investment Advisors met the team of DSP Blackrock AMC (including Gauri Sekaria fund manager of DSP BlackRock Equal Nifty 50 Fund) – I was part of the group. They shared their views on passive funds, how they are doing across the globe, their future in India & their plans (Blackrock is world biggest Asset Management Company – even in passive funds they are bigger than Vanguard). We had a very good discussion – we also suggested that you start with index funds & maybe later ETFs can be introduced. (in ETF Liquidity & managing them is still a major issue in India)

Please share your views on the Index funds & ETFs – feel free to ask questions regarding DSP BlackRock Equal Nifty 50 Fund.

What is Systematic Withdrawal Plan & How does it Work?

Mutual Fund

Hemant Beniwal

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September 28, 2017

25

What is Systematic Withdrawal Plan & How does it Work?

Systematic Withdrawal Plan or SWP is relatively a new concept in India – here Mutual funds give the choice of regular withdrawal to investors on a monthly or quarterly basis. You can say its just opposite of SIP – in a Systematic Investment Plan where investors can invest a pre-defined amount on a regular basis, in a Systematic Withdrawal Plan (SWP), investors can withdraw pre-defined money from the scheme they have invested in on a regular basis.

This is a detailed post & will cover everything that you want to know about SWP – benefits, disadvantages, taxation, annuity vs SWP, Systematic withdrawal Plan example & performance charts. You can also check a Short Video.

Systematic Withdrawal Plan Benefits

SWP if used smartly is helpful in different ways.

What is Systematic Withdrawal Plan & How does it Work? Click to Tweet

It can be used for creating a regular income flow.
It can be used for expenditure items like charity or fees for a specialised course.
It can be used during retirement for monthly expenses when a regular flow of income is not there.
As very limited investment options are available for the senior citizen – SWP can be a good way to generate regular income.

Systematic Withdrawal Plan Advantage over FDs – Video

Systematic Withdrawal Plan Examples

1. I have invested in MIP schemes of Mutual funds. How are SWPs different from MIPs?

Monthly Income Plan schemes of Mutual funds promise to deliver a monthly income in the form of a dividend for the investor. They are debt funds that are linked to the market (10-25% depending on the fund is invested in equity) so regular returns are not guaranteed. If the fund does not perform well dividend payments are not made. This defies the purpose of MIP, which is to provide income at regular intervals.

Moreover, the dividend of debt funds is taxed in the hands of the mutual fund. So the dividend distributed is dividend earned by the scheme less tax which means the investor ultimately get less amount.

If you opt for Systematic Withdrawal Plan on the other hand from your investments in Equity and Debt Mutual Funds, you will get a regular source of income as you are withdrawing from your investment. You can decide the amount and the timeframe you want. So your capital will appreciate and your dividends will accumulate depending on market conditions, but your income flow will be regular. So in an MIP, you can never be sure about the exact amount you will receive but in an SWP, you can decide the amount you want and you will get it provided its there in your investment account.

2. I am a retiree, I have invested in FDs and Post Office Savings Schemes. I get regular income from that. Why should I go for SWPs?

Let us look at an example of Rs. 1,00,000 invested in Bank FD, Post Office Scheme and an Equity Mutual Fund, MIP Mutual Fund. (Compare Systematic Withdrawal Plan SBI Magnum Balanced Fund Vs ICICI Pru MIP 25)

	Bank FD	Post Office Scheme Monthly Income Scheme	MIP Mutual Fund (ICICI Prudential MIP 25 (G))	Equity Oriented Fund (SBI Magnum Balanced Fund)
Amount Invested (Rs.)	1,00,000	1,00,000	1,00,000	1,00,000
Returns per year (Rs.)	3966	7600	12.23% From Aug 2016 to July 2017, the total dividend received was Rs. 7,332	14.81% Total Capital is Rs. 1,02,416 due to capital appreciation
Returns per month (Approximated and averaged in some cases)	330	630	610	1,000
Other features	Interest is taxable. There is a penalty for premature withdrawal.	Interest earned is taxed. One has to invest for 5 years. Penalty for premature withdrawal	Income from Debt Funds is taxable. There is no penalty for withdrawals except an exit load if more than 10% of the amount is withdrawn within 1st year. Expenses have to be paid for professional management	The capital returns are taxable. If the SWP starts one year after investment, capital gains tax can be avoided. For units in excess of 10% of the investment, 1% will be charged for redemption within 1 year.

Note – Withdrawal Rate is very tricky concept – check 4 charts at the end of this post.

As you can see, the SWP option is best for regular income as well as capital appreciation. It can help beat inflation.

It has a higher risk compared to Bank FDs and Post Office Monthly Income Schemes in terms of market volatility. On the other hand, there is not much guarantee of returns from the bank if there are major issues. Moreover, the interest rates on Bank FDs and POMIS have been going downwards.

As a retiree, your key concerns will be –

Having a fixed regular flow of income to meet your expenses
Capacity to beat inflation
Protection of capital

Mutual Fund schemes cannot guarantee returns or capital appreciation but are professionally managed. One should choose stable funds with risk matching one’s capacity and invest in those and have an SWP started. If it is difficult to choose funds, one can approach a professional financial planner.

In SWPs, one can select the amount one wishes to withdraw and the time period. SWPs can bring in a discipline in savings. Usually, equity-based funds have the capacity to beat inflation. Blue chip funds protect capital as the managers are well versed with the markets.

Systematic Withdrawal Plan Taxation

SWPs can be quite tax efficient for investors. If an investor sells units of an equity mutual fund scheme within one year of purchase, he has to pay short-term capital gains tax of 15%. In case of debt funds, short term capital gains will be taxed as per your income-tax slab. Long-term capital gains will be taxed at 20% tax rate with indexation.

The withdrawals using SWP will be usually smaller amounts. In the first year of withdrawal, the amount will be from the principal investment amount. So the withdrawal will not be taxable. To make SWP extremely efficient, it is better to start withdrawing one year after the initial investment in case of equity/balanced funds. Learn more about mutual fund taxation here.

What is the SWP Disadvantage?

SWPs can attract exit load if started immediately. It is better to set up the SWP a year after the initial investment is made.
Mutual funds can be affected by market volatility. Depending on one’s risk tolerance, one should invest in equity oriented or debt oriented MF schemes.
Investors opting for SWP may have to pay tax on short-term capital gains or long-term capital gains depending on the time frame and fund they choose. It is important to ensure that taxes are paid off and also set up the SWP such that the taxes payable are minimum or nil.
You will get a fixed stream of money in SWP but if you want inflation adjusted – you have to do it make chages in your plan regularly.

Annuity Vs SWP

Systematic Withdrawal Plan Mutual Fund innovation to compete with annuities. Annuity and SWP are based on the same principle of Fixed withdrawal. An annuity is Guaranteed based on the plan that you have chosen but is taxable. Once you buy an annuity you don’t have any control over that money. In SWP there is no guarantee but you have the option to increase or decrease withdrawal amount. Annuity is not inflation adjusted – with SWP you can build that plan.

Annuity is a huge asset management market globally – in India it’s still at a nascent stage. You can read more about annuity in LIC Jeevan Akshay Annuity Plan post.

SWP Performance Charts

As a concent, SWP may sound simple but it’s not. Problem is how to decide withdrawal rate, how to adjust that for inflation, what should be the asset allocation, what will happen if markets will fall in the initial years.

You can see SWP returns of Balanced fund category (Hybrid Equity Oriented) in the below chart. If someone started with Rs 1 Lakh in 1991 & withdrew Rs 666 per month (or 8% of initial investment) – in last 26 years he has withdrawn more than Rs 2 Lakh & right now sitting on double the money he invested initially. That may sound wow but what about inflation – Rs 666 has lost its purchasing power. This data starts from 1991-92 (infamous Harsha Mehta Period) – you can see the impact of market fall in initial years. (Value of Initial Corpus was down by 40% after 10 years)

Below graph is bit different – here investor is not withdrawing fixed amount but a fixed return of 8%. So when his corpus was 1 Lakh he got Rs 666 per month but when it went down to Rs 80000 he got Rs 533 per month. When portfolio touched Rs 2 Lakh – he withdrew Rs 1332 per month. Mutual Funds don’t offer such plan but you can create.

There’s no Best Systematic Withdrawal Plan – you have to look at your risk profile & identify the scheme based on that. In the USA there’s a thumb rule of 4% safe withdrawal rate (on balanced fund kind of product – 60% equity) which is well researched but in India data is very limited so planners have their own rates.

Another issue is for Indians even understanding equity volatility is challenging – they are not ready to digest 60% in young age, will they accept that in retirement. So for them, MIP (25% equity) kind of product can be more suitable with lower withdrawal rate.

In below graph, you can see Rs 666 withdrawal (8%) from balanced fund & MIP (Hybrid debt oriented Aggressive). You can notice volatility & amount difference after 25 years. Another thing that you can notice here is I have used this data from August 93 (In first graph it was September 91) – when equity market was at the bottom after Harshad Mehta scam. If you compare the value of balanced fund corpus – it’s 3 times of what if you started in 1991.

Systematic Withdrawal Plan Risk can be understood by below chart – here I have assumed a fixed withdrawal of 10% (Rs 833 per month) of the initial investment. You can see that corpus in MIP is almost Zero. So if you keep higher withdrawal rate – there’s huge risk that your capital will be wiped out much before your desired tenure.

SWP Strategy

After retirement, one may not have a regular income channel. But expenses will continue to be there. Some expenses might increase and some might decrease. It is important to have an appropriate strategy to get regular income during retirement. It is important to manage money smartly so that one does not have financial woes in the retirement years. If one invests an appropriate amount as per the financial plan in MFs when he/she has a regular income, SWPs can be set up during the retirement years for regular income.

If you have any questions regarding SWP – feel free to ask in the comment section.

What is Planning Fallacy and how it affects your finances?

Hemant Beniwal

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September 22, 2017

5

What is Planning Fallacy and how it affects your finances?

If you think Planning Fallacy is only related to Financial Planning – you are wrong. Check why do we fall prey & how to avoid planning fallacy – in this post.

The initial deadline for the Navi Mumbai Metro Rail link was December 2014. Three extensions later, the current deadline has been set for December 2017. The delay has led to an increase in the cost from Rs.1,985 crore toRs.3,000 crore!

HealthCare .gov is the health insurance site operated by the U.S. federal government for people to buy private health insurance and getting subsidies if they are within a certain income level. The estimated cost was USD 93.7 million and the actual amount spent on it was USD 292 million.

These are big projects that have the support of the best expertise and government. But they failed. As you can see, the planning and execution in these cases are not aligned. These projects have not been successful as planned due to the planning fallacy.

Check – Holding Cash – Are You Holding Too Much of It?

What is Planning Fallacy

As defined by Nobel Laureate Daniel Kahneman and Dan Lovallo,

“the planning fallacy is our tendency to underestimate the time, costs, and risks of future actions while at the same time overestimate the benefits of those same actions.”

We as individuals also fall to planning fallacy. We often overrate our abilities and skills – this can affect our personal finances. We set unattainable goals, believe that we know how to make investment decisions or overestimate our earning capacity. This can lead to problems in our financial life.

My Example 🙂 When I got an opportunity from CNBC to write my “Financial Life Planning” book – they asked when I will submit. I did a rough calculation based on my experience on TFL blog – 6 Months. It took me almost a year to finish that.

What is Planning Fallacy and how it affects your finances? Click to Tweet

Why do we fall prey to planning fallacy?

When we plan or asked to estimate the time or cost to do a task, we visualize the event to happen just like we plan it or rather we expect it. We do not think of delays or unexpected scenarios. In this case, usually, the planning falls short of execution.

In the book, ‘The Art of Thinking Clearly‘, Rolf Dobelli, has said that we usually overestimate what we can do and underestimate costs and risks. We should avoid such wishful thinking.

For example, when we plan the budget to buy a house, many of us overlook costs associated with making the house livable (civic amenities), club membership charges, security charges etc. This can lead to heartache later when we have to pay more and also mess up the budget.

Similarly, when we are planning our retirement fund, we might underestimate medical expenses claiming that we are fit or tax payable assuming that our retirement income will be close to nothing. We might underestimate the inflation rate. We might plan for reduced expenses. Yes expenses in the form of children’s education or loan repayments might reduce. But on the other hand, expenses related to medical reasons, domestic help and travel and commute might increase with old age. For example, you may not be able to walk to all places or use taxi services more often.

Now for the million dollar question –

How to avoid Planning Fallacy?

Here are some methods that you can follow to avoid falling into the trap of the planning fallacy –

1) Learn from mistakes – All of us have made planning mistakes. We either underestimate the time for a task or the cost. It could be something like reaching for a meeting on time or estimating the cost of hospitalization. It is best to keep in mind what we planned and what we did not consider while planning – no taxi available, underestimating the number of days to get discharged from the hospital, or assuming a lesser number of medicines while in hospital etc.

2) Use software/ professional advice while planning finances – All of us do not have the time, energy or inclination to plan our finances meticulously on our own. It is best to leave it to the experts. We can use software tools for budgeting, investment portfolio, and many other personal finance tasks. The other option is to utilize the services of a professional financial planner who will build an investment portfolio for you depending on your goals, current financial situation and a realistic view. For example, if you have been saving 5% of your income every month, you cannot suddenly start saving 25% from the next month and so you cannot increase your estimated expenses to any amount. It has to be realistic.

3) Bring in discipline – Discipline is a quality that we can use in all aspects of life. Instead of blindly following news and tips for investment, we can read up and enhance our knowledge of personal finance and the economy. We can look at past data and broaden our perspective of the world to understand what works and what does not work. This will help us to plan ahead.

4) Review your plan regularly – It is advised to have regular medical health check-ups so that any ailments can be detected early on. Similarly, it is important to review the financial plan regularly.

This helps to determine the progress and how different events in life be it marriage or a bonus have affected the plan. If the plan has been significantly affected, the goals might be affected. Then it is important to tweak the plan to suit the current situation. The standard of living, bad performing investments, insurance needs etc. can change necessitating a change in the financial plan.

We can avoid the planning fallacy by having quantifiable and realistic objectives and taking steps to ensure that we stay on track. Having an impartial view of events, using past experience and appropriate use of professional tools and advice can steer us away from planning fallacy.

If you liked this post must share with your friends. I shared my Planning Fallacy – will love to hear your story in the comment section.

Where is Your Post Retirement Plan? Bitter but Truth

Financial Planning

Hemant Beniwal

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September 7, 2017

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Where is Your Post Retirement Plan? Bitter but Truth

Do you have Post Retirement Plan? Life is not going to end on the day you retire & if we talk about finance, the issue is even bigger. Recently RBI published a shocking report where they mentioned only 10% of Indians are doing their Retirement Planning (actively think about old age financial security and definitely have a course of action) & 13% have started actively saving for old age. There’s a difference between saving & retirement planning but I give the benefit of the doubt – what about the rest 77%? There’s even a bigger shock, how people are planning to fund their retirement – that you can check in the last graph.

A similar study was done by HSBC in India – some of the findings of the survey –

61% of Indians above the age of 45 want to retire in the next five years BUT
71% of the people who think they cannot retire even though they want to believe lack of financial readiness is preventing them from retiring.

Read – Best Investment After Retirement

Do Indians have Post Retirement Plan?

A shocking report from RBI published recently has the following observations –

The share of mortgages in total liabilities increases as people approach retirement age. This means debt exposure increases as one grows older which is not a good thing for one’s finances.
Households convert gold holdings to real estate as they grow richer. They do not increase allocation towards other financial assets or retirement portfolios.
There are different products available in India – pension accounts like NPS, investment-linked life insurance products, LIC Pension Plan, etc. but their use is negligible in many states. They are used up to a small extent in a few states. (We don’t suggest mixing insurance & investment.
In the survey, 44% of people have not thought about retirement planning as they feel they cannot retire from work, and 33% of people know they will retire one day but have not thought or planned anything about it! 77% – that is a big number of people who have not planned their finances and are definitely not giving the right sign.
40% of people depend on their spouse or on themselves to make financial decisions. This is fine if the spouse or the person is an expert otherwise it can be a risky proposition.
When people were asked to name the sources of funds for retirement, more than 50% said they will be dependent on their children for post-retirement plans and about 25% of them said they did not know what they will do when they retire. This shows a lack of financial maturity.

77% people have no Post Retirement Plan – RBI

Read What is Insurance?

post retirement financial planning — post-retirement Plan In India

SHOCK – 50% Indians depending on their Kids for Retirement

Check –Are you ready for your Retirement?

How much should I plan for retirement in India?

Where would you stand if you were part of these retirement surveys? Do you know how much money you need during your retirement? Have you planned for retirement? Do you have a diversified investment portfolio?

Let us find out how much money you would need post-retirement –

Current Monthly Expenditure Expenses (Rs.)	20000
Current Yearly Expenditure (Rs)	240000
Number of years left for retirement (years)	20
Average Inflation (%)	6
Yearly Expenditure when you retire (Rs.) (assuming 80% of current yearly expenditure will be incurred post-retirement)	615770
Yearly Expenditure 10 years after you retire (Rs.)	1102750

Where is Your Post Retirement Plan? Bitter but Truth Click to Tweet

As you can see, the expenditure after retirement can be huge. Retirement planning has to be considered seriously. Many people do not want to think about it as they think it is too far away in the future or is scared of planning for it. Some assume their children will take care of their finances as shown in the survey. It is never a good idea to be entirely dependent on others.

Must Read – How much will it take to retire?

Planning for Retirement

You have to plan for your retirement as early as possible –

Start saving and investing from now if you have not started. Each time your income increases, the percentage of savings and investments should also increase. If you are not confident of your investment skills, take the help of professional financial planners.
Plan to pay off debts much before you retire. Avoid taking debts like personal loans or credit card debt when you are closer to retirement.
Invest in different assets – real estate, gold, equity, and debt-based financial instruments. This will ensure optimum returns and also protect you from risks.
Review your investment portfolio regularly so that it remains stable and strong. As you reach different milestones in life or become older, the portfolio will have to be tweaked to suit your current phase of life.
It is very noble to think that you will take care of the education expenses of your children or your relatives’ children. But education is expensive. Rather than blindly committing to such a lofty goal, keep a target amount aside for such things and make sure you have money to take care of your retirement and other needs. Retirement Planning Vs Child Future Planning
Keep aside an emergency fund for unexpected circumstances. Buy medical insurance so that if you fall ill or have to be hospitalized, your finances do not go haywire.

You have to be prepared for your financial future so that you can maintain your lifestyle and have funds to take care of emergencies. The retirement years are called the golden years. If you are prepared financially, you can enjoy this phase by spending time on things that you like and have a stress-free life.

It is important to start planning for it early and methodically. If you have planned for your retirement, you are on the right track and if not, start planning now!. Please share your Post Retirement Plan in the comment section.

Medium Maximisation – biggest Trap that Hinder Happiness

Hemant Beniwal

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August 24, 2017

6

Medium Maximisation – biggest Trap that Hinder Happiness

A ‘Medium’ is something that people get as a reward for doing something. For example, you get reward points for shopping and spending money. But points by themselves do not get you anything. You use the points to buy something which will fulfill your needs and wants.

You work in a company, get money in the form of salary. Money as such cannot be used for eating or entertainment. It can be used to acquire food, clothes etc. It is a medium to fulfill your needs and wants. In many transactions, the equation is –

Effort/Time/Resources → Medium → Outcome

Many research studies indicate that when people are given choices, their selection differs when there is a medium involved.

In a clever experiment, participants were given the option to do one of two tasks- a short one and a long one. For the short task, they would get a Snickers bar and for the long task they had an option to chose one of two chocolate bars – Snickers and Almond Bars. Most people chose the short task.

But then a medium was introduced.

If they chose the short task, 60 points would be given which can be used to get a Snickers bar. If they chose the long task, 100 points would be given which can be used to get one Snickers bar or one Almond Joy. This resulted in people focusing on the points and select the long task as that would maximize the points. But the points here is just the medium. The rewards were same in both experiments but people changed their preference when the medium was introduced.

Must-Read- Money Vs Job Satisfaction

Medium Maximisation

In real life, money is a medium. It helps us get what we want and most of us spend our lives in pursuit of maximising our wealth. This act of pursuing medium is known as Medium Maximisation. “Medium Maximisation is this tendency to focus on the medium instead of the outcome you’re after.”

The medium maximisation effect happens when people are under the illusion that they have an advantage.

Medium Maximisation - biggest Trap that Hinder Happiness Click to Tweet

Another scenario where medium maximisation plays a role is when there is a choice between two options – one is certain and the other is uncertain but the medium reward is certain in both options. The medium reward increases the attractiveness of the uncertain option.

If a task involves some unpleasant activities and in one state people do not have control over them and in the other, people can control them, in most cases the amount of medium that people earn for tasks increases over a period of time but the utility of the money (return on effort) decreases as they have more of it.

Read – How to Live & Die Like Khushwant Singh

Is it optimum to want to maximize the medium or rather choose what you really want in life?

In a Genie study conducted by Raj Raghunathan, people were asked to name the ‘three wishes that you would want if a Genie appeared before you’. (Please take 30 seconds & write the answer on any paper or electronic device before going forward)

People asked for money, fame, power, success, respect and good relationships. Few people asked for happiness. Though the reason why they were wishing for those things is that they want to be happy. People want a medium to reach their goal and they want to maximize the medium. But money itself does not raise the level of satisfaction. For example, in rich countries, wealth has been accumulated more and more but their happiness has not increased considerably.

It has been observed that many people are not content with life even when they earn a lot of money. It could be because they are not spending it the right way or earning the maximum money is not the best way to get what they really want.

Must Check- Can Money Buy Happiness? YES

Ways to maximize what you want rather than the medium –

Think of Money as a Tool –

Stop running behind money and start running behind your goals. You will be able to manage money better if you are working towards reaching your goals. It will help you to be realistic too. Even investing is just the Medium to achieve your goals – focusing too much on products rather than the bigger picture is another example of Medium Maximisation.

Use money as a medium for experiences –

When people buy an object they fancy, they are happy. But after a period of time, the happiness quotient goes down as they are used to owning it. But if they spend money on an experience they have wished for, over a period of time the happiness quotient went up as they look back at their experience with fond memories. Spend money on doing things you like – learning to paint or traveling etc.

Use money to make your life comfortable –

Yes, you need to save and invest money so that you have comfortable future. But it is important to have a pleasant present too. List down things that make your life uncomfortable – You might hate driving or you are unhappy that you do not know anything about personal finance and are worried that you are not managing your money properly leading to anxiety. You can spend money on hiring a driver. You can invest in a course that helps you understand finance. You can hire a professional financial planner who can guide you to manage your money at least in the initial phases if not for a long period of time.

When you will be old, what do you think you will fondly remember?

Working 14 hours daily which gave you more money or the times that you were happy. (Top Regrets of the Dying) It is important to distinguish between the medium and the things that give you true satisfaction. Once you have distinguished between the two, you should pursue those things that give you true satisfaction and maximize them.

Please share your views in the comment section. If you liked the post share with your friends – even they should know if they are on the wrong track of Medium Maximisation.

This Time It’s Different – 4 most dangerous words in Investment world

Hemant Beniwal

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August 16, 2017

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This Time It’s Different – 4 most dangerous words in Investment world

Three magical words ‘I Love You’ & Four most dangerous words This time it’s different – once you are married, you realise even magical words are a trap. 🙂

Sir John Templeton, the investing pioneer had famously said, ‘This time it’s different’ statement is very dangerous. It is very apt for investors – if you often start hearing ‘This time it’s different’ you should start getting worried.

Why do people say ‘This time it’s different’ ?? Because there’s no other way to prove that they are right. This time it’s different can have many interpretations in the markets –

4 most dangerous words in Investment world

1) Making the same mistakes again

Investors tend to make the same mistakes again or make the mistakes other investors made earlier. They do not learn from mistakes. When markets are rising, they feel that “it will be different this time” and do not remember the crash earlier.

For example, in the year 2000, the dot-com bubble and some market manipulation led to the indices zooming upwards. Retail investors bought stocks at high prices. Then the Sensex lost 2000 points in 3 months leading to big losses for retail investors. They did not evaluate the market well. They went along with the herd to buy stocks without understanding the fundamentals.

This Time It's Different – 4 most dangerous words in Investment world Click to Tweet

In 2007, FIIs invested a huge amount in India, this led to a rise in the stock markets – valuation ran much ahead of the fundamentals. Investors again made the mistake of buying at high prices with the reasoning that “this time is different” as there are no dot-com movements and big institutions are investing. Media started publishing articles India needs Infrastructure & real estate blah blah so ‘This time it’s different’. In 2008, the stock market crashed and investors lost again.

Read More – Keep away from too much news

No body was ready to invest in 2008 end because they thought ‘This time it’s different’ – the world is going to end.

Investors feel that this time it is different and they will not make the same mistake again. But this is a delusion. Investors will lose money when they believe without any concrete evidence that ‘this time it’s different’!

Must Read – 7 types of investors in India

2) Historical Returns are important

Past performance is not indicative of future returns – Most mutual funds and investment houses put forward this disclaimer. But past performance (I am not talking about recent past but historical data) is an important parameter to consider while investing. You cannot ignore historical performance by saying “it is different this time”. It gives some idea of the investment and the trend of returns given by the investment.

Read – How an Economic Crisis can be beneficial for Long-term investor

3) Valuations always matter

There will be different bubbles and market conditions that will come and go. But the valuation of investments will remain in place. At different times, the market will be influenced by different conditions. But if your investments have been chosen after careful research, solid fundamentals and good management, the investments will stay on course in the long run. But be frank retail investors don’t have such capacities. It will be better if they have their investment policy statement & stick to that in all season. [ PE Ratio is one of the valuation methods – there are many others ]

Read – Greater Fools Theory & Indian Real Estate

4) Human Greed

Usually retail investors are not able to overpower greed and fear when they invest. This is not different in any part of the world. They try to put all their money in one outperforming asset. They do not exit (rebalance) from the asset at the right time in a bullish market expecting more and more gains and end up losing money. Others fear losses and do not invest in the market at all till their friend bought a car after selling scooter. Some people hold on to bad investments as they are scared of losses.

It is good to want to optimize your returns and be cautious in the market. But at different times there will be different reasons for volatility in the market. It is important to recognize that and attach the requisite importance to valuation.

Read – The art of thinking clearly

SIP myth – investors are now mature

If you are investing through SIP in Mutual Funds, you may not like it. These days when we interact with fund managers & other people in Mutual Fund industry – they keep saying that ‘This time it’s different’ investors are now mature. They show the data of SIP numbers or may be some equity investment numbers in the last dip to prove their point. SIP is undoubtedly a great way to invest but this is now becoming more of a fancy item rather than means to achieve goals. Investor expectations are too high & at least I am not ready to buy that there is a relation between a number of SIP & investor maturity. I will be more than happy if I will be proved wrong 🙂

It is important to differentiate when things seem different and when things are really different. Is there really a reason that is making a difference leading to the rising or falling markets or is it just herd behavior forcing the markets to behave in a certain manner which would of course be a temporary phase.

Please share your views & experience in the comment section – also try to recall what you thought about property investment & gold investment .

Effect of Holding Period on Returns and Risks – beyond your imagination

Investment Planning

Hemant Beniwal

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July 20, 2017

6

Effect of Holding Period on Returns and Risks – beyond your imagination

Investments in stocks (Equity), bonds (debt), and mutual funds involve a certain amount of risk. You cannot estimate the level of risk accurately as there are many variables in play – past performance, current performance, micro, and macroeconomic factors. You cannot eliminate risk entirely and therefore you should make the portfolio diversified such that the risk can be managed – plus you should have a clear idea about your Holding Period or in simple terms Investment Horizon for a particular Goal.

I can assure that this post & data will blow up your mind 🙂

What’s your Investment Horizon?

This is US data – clearly shows that only 8% are planning for entire life. The situation in Indian will not be much different. A decade back when I was in the job – I was not discussing goals with the clients but I always asked them about their investment horizon. Whatever that number was I took that at face value & suggested an investment that matches that. (still, most of the clients & advisor follow this) But when I started working on plans – I never asked this question because I know client’s time to reach a goal is going to be his investment horizon or Holding Period.

Effect of Holding Period on Returns and Risks - beyond your imagination Click to Tweet

For example, if your age is 30 & daughter is 1 year old – for her higher education goal, the investment horizon is 16-17 years. If you are planning to retire at the age of 55 & we assume the life expectancy of 80 – your holding period for part of your portfolio will be 50 Years. 50 Years. 50 Years.

As above image shows – people don’t think that long term. This article is only relevant if you understand your investment horizon.

Holding Period

The holding period is the period of time during which an investment is attributed to a particular investor. The holding period is an important factor in risk and returns. Holding period of the portfolio has weightage on individual assets too.

The Holding Period Return (HPR) is the total return earned from an investment or an investment portfolio over the holding period. The holding period is the tenure for which the asset or portfolio was held by the investor.

Holding Period Return formula

Income + (End of Period Value – Initial Value) / Initial Value

Annual Holding Period Return formula

{(Income + (End of Period Value – Initial Value)) / (Initial Value+ 1)} ^1/t– 1

Here is a study of the portfolio of stocks and bonds and the holding period for 4 types of investors –

Usually, you hear that the higher the risk, the higher the returns. But all of us cannot invest in the most risky assets to get the maximum returns. It is not prudent to do so. And we all have different risk appetite and risk tolerance levels.

The four types of investors considered are –

Ultra-conservative investor – He requires maximum safety irrespective of the returns,
Conservative investor – He accepts some amount of risk to get extra returns
Moderate risk-taking investor – He accepts a higher amount of risk to get more returns
Aggressive investor – He is willing to accept substantial risks in for high returns.

What percentage of an Investors’ portfolio should be in stocks?

Source : Stocks For The Long Run

If you are not rubbing your eyes right now – you have not understood above table. Check again 🙂 (above table is suggesting that even if you are an ultra-conservative investor but your horizon is 30 years – you will be better off by taking 71.3% equity exposure in your investment portfolio. That doesn’t mean there’s no risk.) As you can see the lower the risk tolerance level, the lower the share of stocks but it increases as the holding period gets longer. In the long run, stocks have the potential to give the best returns. So even as a person wanting to take low risk, the stocks allocation can be increased provided the holding period is substantial.

Author Jermey Siegel did research on last 200 years US market data & reached this suggestion. Can this be applied to India? No idea but universal truth is “in long term stocks are safer than bonds in terms of purchasing power”.

Read – Long term & short term Investment

Risk, Return & Holding Period

The chart below shows the average annual returns of a portfolio over different time periods. The square in the curve indicates an all bond (Debt/FD) portfolio and the ‘X’ indicates an all stock portfolio.

The circles in each curve indicate the minimum risk possible by combining investments in stocks and bonds. The curve that connects these points represents the risk and return of all types of portfolios. The portfolios can be 100% stocks or 100% bonds or an equal mix of stocks and bonds. This curve is called the efficient frontier. By finding the points on the longer-term efficient frontiers that equal the slope on the one-year frontier, one can determine the allocations that represent the same risk-return trade-offs for all holding periods.

Note – Standard Deviation (investment volatility) is Considered as Risk. (Read – 15 types of Risk) This is US data & Indian numbers can be totally different but another universal truth that “risk will reduce with increase in holding period” will not change.

Source : Stocks For The Long Run

Minimum Risk Point – You can observe that in long term overall risk is reduced with an increase in equity exposure. Once Minimum Risk Point is crossed increasing exposure to equity can increase return but the risk will also be increased.

Read – PMS services in India – are they better than Mutual Fund?

Indian Example – Relationship between Holding Period & Risk

This is 38 Years Sensex data & table is prepared by one Mutual Fund Company
Be frank in investment world 38 years is very short term to reach any conclusion but still, findings match with the US data
Loss Probability & Standard Deviation (Risk) are reducing with increase in time horizon
If your Holding Period is less than 10 years, there are still chances that you see negative returns. (theoretically, if I add dividend of approx 2% – 7 & 10 year period can go in green)
If we look at Average Returns (5 to 15 years) is around 15-16% – this is very close to Indian GDP + Inflation (So in long term fundamentals will decide the direction of market)
The range of returns (the difference between Max Returns & Minimum returns) will become narrow in long term.
Not in the above table – but till date in India, Average Mutual Funds have done better than Index. But no guarantee that this will be repeated in future.

It is important to factor in holding period of the investment portfolio in the calculation of returns and assessment of risk. In the long run, holding only bonds/debt based instruments is not the best action as they will not be able to sustain your purchasing power. In the long run, stocks are a good bet to beat inflation but your expected returns should be lower.

Of course, it goes without saying that stocks have to be selected after careful research and analysis of stock and market factors or it will be better that you stick with Mutual Funds.

Please share in the comment section what comes to your mind when you think about risk & returns.