Vivek Kaul
One of the investment lessons that gets bandied around when it comes to investing in the stock market is that stocks are for the long run. Of course, no one really gets around to tell you how long is the long run.
The BSE Sensex touched an all time high level of 21,919.79 points on March 7, 2014. As I write this it is at 21,942.11 points, which is higher than the all time high it touched on March 7. During the course of trading today (i.e. March 10, 2014), it even crossed 22,000 points briefly.
The question is what are the returns that the Sensex has generated. Between January 2, 2008 and March 7, 2014, the Sensex has given an absolute return of just 7.11%. Yes, just 7.10%, over a period greater than six years.
You, dear investor, would earned significantly better returns by just letting your money lie idle in a savings bank account which pays an interest of 4% per annum (or actually 2.8% if you come in the 30% tax bracket). If you had made the effort to move your money into a bank, like Yes Bank, which pays up to 7% interest on the money deposited in a savings bank account, you would have done even better. And these returns would have been guaranteed, unlike the returns from a stock market. So much for stocks being the right investment product for the long run.
The BSE Sensex is made up for 30 stocks listed on the Bombay Stock Exchange. And in the last six years the stocks that constitute the index have been changed majorly. Dhirendra Kumar of Value Research points out in a column that “ The Sensex has seen large changes since that time. Nine of the thirty companies have been replaced. It’s literally not the same Sensex any more.” And if one were to re-calculate the value of the Sensex assuming these stocks would have continued to be a part of the Sensex, the Sensex would have actually been at 20,400 points today, writes Kumar. This is close to around 6% lower than the March 7 high that the Sensex achieved. Also, this is not totally accurate given that one of the companies Satyam Computers, no longer exists.
So a buy and hold strategy on the Sensex does not really work. But does that mean you should not invest in the stock market? Should you stay away? Not at all.
The best way to invest in the stock market continues to be a systematic investment plan(SIP). If you would have started an SIP on the HDFC Equity Fund in January 2008 (which was one of the better funds back then) it would have given you a return of 12.96% per year, assuming had continued your SIP till date through the ups and downs of the stock market.
You would have done even better if you had started an SIP and invested regularly in ICICI Prudential Dynamic Fund. The returns in this case would have amounted to 14.43% per year. An SIP on DSP Black Rock Top 100 fund (which was also one of the better funds back then) would have earned you a return 9.54% per year, whichi is not as high as HDFC Equity Fund or ICICI Prudential Dynamic Fund, but not bad nonetheless.
Also, it is worth remembering that these returns are tax free. Any mode of investment giving a tax free return of 9% or higher, in these difficult times, is a pretty good bet.
Of course, most people would have missed out on these returns, given that they would have started to cancel their SIPs once the stock market started to fall in 2008, in the aftermath of the financial crisis. But what they forgot is the basic principle behind an SIP.
For SIPs to give good returns, the stock market needs to move both up and down. When the stock market goes down, then investors are able to buy a greater number of mutual fund units for the same amount of money. And these units bought when the markets are low, provide the kicker to the overall returns once the stock market rallies.
When it comes to mutual fund SIPs, it is best to remember the old Hero Honda advertisement. Fill it, shut it, forget it.
Discloure: Vivek Kaul is a writer. He tweets @kaul_vivek. He invested in all the mutual funds mentioned in the piece, through the SIP route, at some point of time.
The article originally appeared on www.FirstBiz.com on March 11, 2014
Personal Finance
Personal finance advice in 87 words: Lessons on investing from Scott Adams
![scott adams[1]](http://teekhapan.files.wordpress.com/2014/02/scott-adams1.jpg)
Vivek Kaul
One of my bigger mistakes in life was to spend two years doing an MBA. ‘Herd mentality’ usually leads to disastrous decisions. After completing my MBA, I discovered Scott Adams and his cartoon character ‘Dilbert’. Dilbert(and effectively Adams) taught me more about management and how companies ‘really’ work, than two years I spent at a business school.
Interestingly, in the recent past, I have also picked up some basic personal finance lessons from reading a few books written by Adams. In his latest book How to Fail at Almost Everything and Still Win Big, Adams shares some of his experiences and draws a few personal finance lessons from them.
When the dotcom boom was on, Adams invested in this start-up called Webvan. “You could order grocery-store items over the Internet and one of Webvan’s trucks would load your order at the company’s modern distribution hub and set out to service all the customers in your area,” writes Adams.
He thought that Webvan would do for grocery what Amazon had done for books and bought the shares of the company. As the dotcom bubble lost steam and the stock price of Webvan fell, Adams bought more stock (probably following the strategy of dollar cost averaging). As the price of the stock fell, he repeated this process several times.
As Adams writes “When management announced they had achieved positive cash flow at one of their several hubs, I knew I was onto something. If it worked in one hub, the model was proven, and it would surely work at others. I bought more stock.”
A few weeks later, Webvan went out of business. “Investing in Webvan wasn’t the dumbest thing I’ve ever done, but it’s a contender…What I learned from the experience is that there is no such thing as useful information that comes from a company’s management.”
Adams also talks about this phenomenon in the context of professional stock analysts in his book Dilbert and the Way of the Weasel. As he points out “Professional stock analysts can do something that you can’t do on your own, and that is to talk directly to senior management of the company. That’s how a stock analyst gets all the important inside scoop not available to the general public, including important CEO quotes like this: “The future looks good!””
After his disastrous experience with Webvan, Adams decided to that get some professional help in investing all the money that he was making once the royalties of Dilbert started to pour in. As he writes in How to Fail at Almost Everything and Still Win Big “I didn’t have the time to do my own research. Nor did I trust my financial skills…My bank, Wells Fargo, pitched me on its investment services, and I decided to trust it with half of my investible funds. Trust is probably the wrong term because I only let Wells Fargo have half; I half trusted it. I did my own investing with the other half of the money.”
The results of the half trust weren’t any good either. “The experts at Wells Fargo helpfully invested my money in Enron, WorldCom, and some other names that have become synonymous with losing money. Clearly investment professionals did not have access to better information than I had. I withdrew my money from their management and have done my own thing since then,” writes Adams. He has been investing in index mutual funds since then.
Adams discusses the problem of listening to so called experts in Dilbert and the Way of the Weasel. As he writes “My problem is that I listen to financial experts, who give valuable advice for moving my money from me to them. My first clue that experts are less than omnipotent might have been that they all recommended different and conflicting things. The one thing that all their recommendations have in common is that is that if you follow their advice, they will get richer.”
Adams also talks about the importance of investors concentrating on systems and not goals. “Warren Buffett’s system for investing involves buying undervalued companies and holding them forever, or at least until something major changes. That system (which I have grossly oversimplified) has been a winner for decades. Compare that with individual investors who buy a stock because they expect it to go up 20 percent in the coming year; that’s a goal, not a system. And not surprisingly, individual investors generally experience worse returns than the market average,” writes Adams in How to Fail at Almost Everything and Still Win Big. This is a simple but a very important point to understand for every investor.
In fact, Adams once even tried to write a book about personal investing. As he writes in Dilbert and the Way of the Weasel “It was supposed to be geared toward younger people who were investing for the first time. After extensive research on all topics related to personal investing I realized I had a problem. I could describe everything that a young first-time investor needs to know on one page. No one wants to buy a one-page book even if that page is well written…People would look at it and say, “That’s all well and good, but I’m paying mostly for the cover.””
In fact, the plan was not even one page. It was just 87 words and here it is:
Make a will. Pay off your credit cards. Get term life insurance if you have a family to support. Fund your 401k to the maximum. Fund your IRA(individual retirement account) to the maximum. Buy a house if you want to live in a house and can afford it. Put six months worth of expenses in a money-market account. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement. (as described in Dilbert and the Way of the Weasel) (401k and IRA are essentially what we call provident funds in India).
These 87 words summarise all that is there to know about personal finance.
The article originally appeared on www.FirstBiz.com on February 15, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why investors behave like football goalkeepers and how that hurts
Vivek Kaul
A very good friend of mine recently decided to take a sabbatical. But two weeks into it he started getting fidgety. The prospect of not doing anything was turning out to be too hot to handle for him. So, one morning he called up his boss and told him that this decision to go on a sabbatical was not the right one, and given this, he wanted to get back to work.
My friend’s boss, had taken a sabbatical last year, and understood the value of a big break away from work. Given this, he refused to let my friend get back to work so soon, and suggested that he continue with the sabbatical, now that he had decided to take one.
One more week into the sabbatical, my friend simply couldn’t handle it. One day he simply landed up at work, without consulting his boss. And thus ended his sabbatical.
The point in sharing this story is that it is difficult “do nothing”, even though at times it might be the most important thing to do.
In a recent interview to Wisden, the former Australian cricketer Dean Jones, pointed out that two thirds of Sachin Tendulkar’s game was based around forward defence, back-foot defence and leaving the ball, without trying to play it. As Amay Hattangadi and Swanand Kelkar write in a research eport titled The Value of Doing Nothing and dated February 2014 “As any coach would vouch, letting the ball go is possibly as important as hitting good shots in the career of a batsman.”
In fact, not doing anything is a very important part of successful investing. But the investment industry is not structured liked that. They have to ensure that their customers keep trading, even if it is detrimental for the them. As Arthur Levitt, a former Chairman of the Securities Exchange Commission, the stock market regulator in the United States, writes in Take on the Street – How to Fight for Your Financial Future “Brokers may seem like clever financial experts, but they are first and foremost salespeople. Many brokers are paid a commission, or a service fee, on every transaction in accounts they manage. They want you to buy stocks you don’t own and sell the ones you do., because that’s how they make money for themselves and their firms. They earn commissions even when you lose money.”
The brokers only make money when investors keep buying and selling through them. This is also true about insurance and mutual fund agents, who make bigger commissions at the time investors invest and then lower commissions as the investors stay invested.
As Adam Smith (not the famous economist) writes in The Money Game “They could put you in some stock that would go up ten times, but then they would starve to death. They only get commissions when you buy and sell. So they keep you moving.”
Levitt proves this point by taking the example of Warren Buffett to make his point. “Warren Buffett, the chairman and CEO of Berkshire Hathaway Inc and one of the smartest investors I’ve ever met, knows all about broker conflicts. He likes to point that any broker who recommended buying and holding Berkshire Hathaway stock from 1965 to now would have made his clients fabulously wealthy. A single share of Berkshire Hathaway purchased for $12 in 1965 would be worth $71,000 as of April 2002. But, any broker who did that would have starved to death.”
Hence, it is important for stock brokers, insurance and mutual fund agents to get their investors to keep moving from one investment to another.
But how do stock brokers manage to do this all the time? Andy Kessler has an excellent explanation for this in Wall Street Meat. As he writes “The market opens for trading five days a week… Companies report earnings once every quarter. But stocks trade about 250 days a year. Something has to make them move up or down the other 246 days [250 days – the four days on which companies declare quarterly results]. Analysts fill that role. They recommend stocks, change recommendations, change earnings estimates, pound the table—whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions.”
But why are these analysts taken seriously more often than not? As John Kenneth Galbraith writes in The Economics of Innocent Fraud “ And there is no easy denial of an expert’s foresight. Past accidental success and an ample display of charts, equations and self-confidence depth of perception. Thus the fraud. Correction awaits.”
This has led to a situation where investors are buying and selling all the time. As Hattangadi and Kelkar point out “In fact, the median holding period of the top 100 stocks by market capitalisation in the U.S. has shrunk to a third from about 600 days to 200 days over the last two decades.” Now contrast this data point with the fact that almost any and every stock market expert likes to tell us that stocks are for the long term.
This also happens because an inherent action bias is built into human beings. An interesting example of this phenomenon comes from football. “In an interesting research paper, Michael Bar-Eli2 et al analysed 286 penalty kicks in top soccer leagues and championships worldwide. In a penalty kick, the ball takes approximately 0.2 seconds to reach the goal leaving no time for the goalkeeper to clearly see the direction the ball is kicked. He has to decide whether to jump to one of the sides or to stay in the centre at about the same time as the kicker chooses where to direct the ball. About 80% of penalty kicks resulted in a goal being scored, which emphasises the importance a penalty kick has to determine the outcome of a game. Interestingly, the data revealed that the optimal strategy for the goalkeeper is to stay in the centre of the goal. However, almost always they jumped left or right,” write Hattangadi and Kelkar.
Albert Edwards of Societe Generale discusses this example in greater detail. As he writes “When a goalkeeper tries to save a penalty, he almost invariably dives either to the right or the left. He will stay in the centre only 6.3% of the time. However, the penalty taker is just as likely (28.7% of the time) to blast the ball straight in front of him as to hit it to the right or left. Thus goalkeepers, to play the percentages, should stay where they are about a third of the time. They would make more saves.”
But the goalkeeper doesn’t do that. And there is a good reason for it. As Hattangadi and Kelkar write “ The goalkeepers choose action (jumping to one of the sides) rather than inaction (staying in the centre). If the goalkeeper stays in the centre and a goal is scored, it looks as if he did not do anything to stop the ball. The goalkeeper clearly feels lesser regret, and risk to his career, if he jumps on either side, even though it may result in a goal being scored.”
Investors also behave like football goalkeepers and that hurts them.
The article originally appeared on www.firstbiz.com on February 8, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Tyranny of choice: What I learnt while trying to buy a new mobile phone
Vivek Kaul
Recently I dropped my mobile phone into a bucket of water. The phone worked for a while and then stopped working. Given that, I had been using the phone for nearly two years now, I thought its time to buy a new one. And this is where my problems started.
I have managed to stay away from using smart phones till now. For the last five years I have been using a dual SIM model from Samsung. Given a choice, I would have wanted to buy the same phone all over again, like I had done two years back. But sadly Samsung doesn’t make that model any more ( at least I couldn’t find it anywhere on the web).
Thus, started the journey to figure out which mobile phone to buy. Gradually, recommendations started coming in. The people around me took it upon themselves to make sure that I bought the right mobile phone.
But looking at the choice that was available I ended up being all confused. First and foremost one needed to decide on the price range. Then on the company. Then on the right model. And how did one do that?
With every phone having so many features, how does one figure out which one was the better phone? In fact, feature creep is a huge problem with modern day products. As Geoffrey Miller, a professor of evolutionary psychology at the University of New Mexico in the United States in his book Spent – Sex, Evolution, and Consumer Behaviour “This [i.e. feature creep] is driven partly by the need to make each new product model different from last year’s, but also partly by the consumer’s unconscious desire for a product that is right at the limit of his cognitive ability, and one that therefore functions as a credible cognitive display. The male buying them thinks those features can be talked about in ways that will display my general intelligence to potential mates and friends, who will bow down before my godlike techno-powers.”
The question is what about those people who just want to use a phone like a phone (i.e. make calls, send smses and probably take a picture or two once in a while). How should they go about choosing the right phone? And ultimately human beings have limited cognitive ability. It is simply not possible for them to analyse a product on every dimension and then make a purchasing decision. As Stefan Thomke, an authority in the management of innovation told me in an interview I did for Forbes India “We have been in many meetings where the entire meeting is dedicated to discussing more and more features. There seems to be an assumption that we are basically done when we can no longer squeeze more features into a product. Presumably assuming that the more features a product has, the customer actually sits there and counts the features, and that somehow drives our ability to price it.”
The consumers tend to simplify this problem by trying to look at one or two dimensions, which they think are important. Take the case of computers. Here people rely on the processor speed of the chip to make a purchasing decision. But is it the right criteria on which a purchasing decision should be based.
As Niraj Dawar writes in Tilt – Shifting Your Strategy from Products to Customers “Like any summary measure of a complex system, speed has its limitations: two computers with the same processor speed on their chips may perform very differently depending on the software loaded on the computer, the transfer speed of inflation to and from memory, its connectivity to the network, and many other variables. But most buyers leave these intricacies to experts and rely instead on the simple summary measure of speed.”
This is how consumer simplify the purchasing decision by looking at an irrelevant criteria. And what true about computers is also true about a lot of other products. As Dawar points out “For example, consumers evaluate digital cameras using the simple summary measures of megapixels, when in fact the megapixel has little to do with the quality of pictures taken by the camera. It is the size of the light sensor rather than the megapixel count that determines picture quality. Similarly, automobile buyers often rely on horsepower as a measure of the muscle of the car, when it is actually torque they are looking for, as torque determines acceleration, which is the sensation that drivers seek. Customers rely on threat count when buying synthetic bed sheets, but threat count is irrelevant in synthetic fabrics—it only provides a measure of quality for natural fibers such as cotton.”
Given these reasons I started looking for an irrelevant criteria using which I could figure out which mobile phone to buy. My search is still on. And as soon as I find one, I will go ahead and buy a new mobile phone. Meanwhile, I did the smart thing. I paid Rs 300 and got my mobile phone repaired. To conclude, let me quote what Thomke of Havard Business School: “We often talk about it as a quote attributed to Leonardo da Vinci that simplicity is the ultimate sophistication. To make things simpler is very hard because that requires you to have a very deep understanding of what the user really wants. And once you have that deep understanding, you have the confidence. Mark Twain once said, if I had more time I would write a short letter.”
The article first appeared on www.firstbiz.com on February 7, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Retail discount ‘sales’: Why high prices and big discounts go hand in hand
Vivek Kaul
The sale season is currently on. If you are the kind who likes to frequent malls on weekends (or even weekdays for that matter) you might have realised by now that discounts are on offer, almost everywhere.
The question is why do retail stores do this? As Tim Harford writes in The Undercover Economist “We’re all so used to seeing a store-wide sale with hundreds of items reduced in price that we don’t pause and ask ourselves why on earth shops do this. When you think hard about it, it becomes quite a puzzling way of setting prices.”
And why is that? “The effect of a sale is to lower the average price a store charges. But why knock 30 percent off many of your prices twice a year, when you could knock 5 percent off year around? Varying prices is a lot of hassle for stores because they need to change their labels and their advertising, so why does it make sense for them to go to the trouble of mixing things up?,” asks Harford.
There are multiple reasons for the same. As Harford writes “One explanation is that sales are an effective form of self targeting. If some customers shop around for a good deal and some customers do not, it’s best for stores to have either high prices to prise cash from loyal(or lazy) customers, or kow prices to win business from the bargain-hunters. Middle-of-the-road prices are not good: not high enough to exploit loyal customers, not low enough to attract bargain-hunters.”
Also, if the firm were to offer a fixed discount (say 5%) all through the year, it wouldn’t be regarded as a discount by consumers at all. This would happen simply because consumers would not have anything to compare a regular discount of 5% with. A regular discount of 5% compared with a regular discount of 5%, essentially implies no discount at all.
For any bargain to look like a bargain what economists call the “anchoring effect” needs to come into play. As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect”.”
The normal price of any product is the “price” a consumer is anchored to. As Barry Schwartz writes in The Paradox of Choice: Why More is Less “The original ticket price becomes an anchor against which the sale price is compared.”
This comparison tells the bargain hunters that a bargain is available and encourages them to get their credit cards out. Interestingly, research shows that people end up spending much more when they use their credit cards than when they spend cash.
Gary Belsky and Thomas Gilovich point this out in Why Smart People Make Big Money Mistakes and How to Correct Them, “Credit card dollars are cheapened because there is seemingly no loss at the moment at the purchase, at least on a visceral level. Think of it this way: If you have $100 cash in your pocket and you pay $50 for a toaster, you experience the purchase as cutting your pocket money in half. If you charge that toaster though, you don’t experience the same loss of buying power that your wallet of $50 brings.”
“In fact, the money we charge on plastic is devalued because it seems as if we’re not actually spending anything when we use cards. Sort of like Monopoly money,” the authors add. Given this, when people do not feel the pain of spending money, they are likely to spend more. “You may be surprised to learn that by using credit cards, you not only increase your chances of spending to begin with, you also increase the likelihood that you will pay more when you spend than you would if you were paying cash,”Belky and Gilovich write.
This benefits the retailer offering the discount. What he loses out on by offering a discount on the product, he more than makes up for through an increase in volumes.
Of course, there are other reasons like trying to get rid of inventory, before a new season comes on. If the retailer has not been able to sell too many jackets during the winter season, he might try to offload it at a discount before the summer season comes on, instead of holding it back till the next winter season. High end designer stores face the risk of styles going out of fashion. Hence, they need to get rid of their inventory pretty quickly. But this doesn’t really hold for everyone (Think about this: how many of us wear clothes that are radically different in style when compared to last year?).
Hence, retailers essentially have sales to get the anchoring effect going, which, in turn, encourages people to get their credit cards out, and spend more money than they normally would. To conclude, here is a tip to avoid the crowds during the sale season. One day before the sale opens, go the store and check out what you want to buy. If you are buying clothes, figure out what you like and check out whether they fit. Visit the store again the next day, and simply pick up the clothes you liked (to the condition that they are on discount). This will ensure you may not have to spend time standing in a queue before the trial room, waiting for your turn.
The article originally appeared on www.firstbiz.com on February 5, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)