Does it pay to be actively involved with your investments? Rohit posted his comments on my earlier post (“Build Leverage“), and Prem has noted this too.
This got me thinking: So is it truly worth it to be involved with your investments? If you can eke out, say, 5% more than the market, on a portfolio of 50 lakhs you are only better by 5 lakhs. That’s not much. Or is it?
The incremental cost of being actively being involved with your investments gives you a much higher longer term return. While the difference may not be visible now, it could be significant later.
Take 50 lakhs. Assume you have a 5% better return than the market. Just 5%. So the market gives you 12%. You can get 17%.
After 10 years, if you went down the market way you would have 1.5 crores. Your way would yield 2.4 crores. A 90 lakh difference.
Consider 6% inflation. Ten years later, the market investment is equal to 87 lakhs of today’s money, and your managed funds is equivalent to 1.34 crores of today’s money.
A 5% differential is worth 57 lakhs today. More than 100% of what you invested!
But how do you get a “better” return than the market?
You can manage your money better. There are just three things in investing.
- Money management: Some of your money should be in “safe” avenues (cash, debt funds etc), and some others in risky avenues like stocks. In stocks, you will allocate only so much money per stock that it does not take up more than x% of your portfolio (say 10%).
- Selection: You need to select stocks that will give you commensurate returns.
- Risk control: Have the discipline to control your losses. Meaning, if the market moves strongly against your trade, how do you react. Control your losses, ride your winners.
This is easier said than done. People are usually excellent at 2) above. But they get emotional about 1) and 3).
To get out of a losing trade requires cutting down your emotions. For instance, I had recommended SRF at 171. When I found it had bad results, the reason for my investing was over. I made an exit call at 146, a loss of about 10%. But had you held on to it, the price today is 127, a further 10% drop. (When things fall 10%, they tend to go on down another 10%)
Stop losses worked here. Even a risk control measure like booking profits helps. For instance my BHEL call was stopped out at 1650. It’s at 1550 today. (And 1650 was at 40% profit) I owned (but had not formally recommended) L&T at 1950. It went to 2600+ and retraced to 2400 which was my exit point. It’s sub-2300 today. It’s not my calls that are important, it’s the rules and the ability to stick by them.
Sometimes you can even book a 50% loss and still do ok. My Marksans Pharma post talks about how, since I got out at 128 – a near 50% loss from my buy price – the price has fallen to below Rs. 50 today.
Risk control does not have to be stop losses. It can be some other way, such as buying puts (or writing calls) to lower the risk of a stock going down.
Money management too isn’t very complicated. You have to assess the amount of risk you can take (which has NOTHING to do with age, no matter what anyone tells you) and divide your money accordingly. In places where you can lose capital, please diversify enough to lower risk potential of an individual trade to less than 2% of your risk portfolio. Meaning, if you have 10 lakhs in stocks, your max loss on a single stock should be 20,000. If one of your stocks is worth 2 lakhs, set up a stop loss at 10% below its current value. If any of your stocks is worth 5 lakhs, the stop is at 4% below current price, which is quite small and you will get stopped out – so bring the weight of that stock down (either by selling some or adding more money into other stocks). That way you can always have 10% stop losses on your risk control while ensuring money management is sound as well.
All in all: Managing your own money, in my opinion, is a worthwhile exercise. For the long term. In the short term, there are bound to be disappointments but you will learn from them and be a better investor. Or even a better trader.