How many women it takes to give birth to a child in one month?

photo courtsey: flickr.com

The question is as simple as it seems. A woman takes nine months to give birth to a baby. So, can we say nine women can deliver a baby in a month! Ridiculous, right? How can nine women do it in a month? Because it’s a process that takes up to nine months, it’s not a mathematics problem that needs algebraic solution. It is an art and a science.

I would say, very logical. Now, what if I put the same logic in investing? On an average, a well-run equity mutual fund garners above-average returns in about 5-6 years.

A quality large-cap equity mutual fund garners an annualized return of 15-20 percent in about five years (on an average), would that also imply that 15-20 mutual funds can do the same magic in one year?

Confusing! Yes, just like my first example investing follow the same rules of art and science.

My case to you is that- long-term wealth creation is not myopic. It is a process of savings, accumulation, diversification, and active monitoring.

What hinders the process is investor’s myopia- an average investor fails to think beyond the period 2-3 years, when holding for long-term. But, how can we ignore the fact that our ancestors accumulated wealth over long-term through regular deposits and holding in avenues including Provident Fund, Fixed Deposits and Kisan Vikas Patra. It is no strange that long-term ‘buy and hold’ works in practice. Anyone invested Rs.1 lac in 1977 in Reliance IPO could have yielded Rs.11.98 crores by 2011 (The Economic Times, 2012), an XIRR of 30%.

Today, information access is no big concern as it was a generation ago. Today everything is available in a pocket (mobile); unlike the times where flow of information remained limited.

But, strangely enough dynamism within financial industry has dwindled the faith of common investor. Today, no one talks about holding a stock for 10 or 15 years. Trend-based investing seems to be the norm of the day. Globally the average stock holding period used to be around seven years in the 1940s; which has dropped to below six months today!

I believe we need to re-learn the practice of ‘buy and hold’. Even a small SIP of five thousand rupees has a potential to grow to twelve lakh in next ten years, sixty one lakh in twenty years and forty three crore in fifty years at the average rate of fifteen percent per annum.

I am not against tactical allocation as our financial needs change with time, age and goals. We need to balance our emotions and follow a discipline per se to attain the long-term goal of wealth building. The hypothesis to understand the investing is not a one-shot game. It is a strategy that needs patience, discipline and self-control. 

Apart from myopic view, over-diversified portfolio also leads to un-optimized returns. A lot of investors ask me, what do you think, how many mutual funds are adequate for my portfolio: ten, fifteen or twenty.  I generally recommend- for a neat equity mutual fund portfolio you need to have following funds:

I        a.  A good-rated large-cap fun

       b. A quality oriented mid-cap & small-cap fund

     c.   One/Two sector-oriented fund (depending on risk appetite and economy)

That’s all! A maximum of five mutual funds will not only garner handsome returns but also keep paperwork and book-keeping to the minimum.

Generally, people have a tendency to hold bouquet of outperforming large caps and aspire to create a large alpha and beat the market. But, at the end, fail to satisfy the urge to beat the markets. The real culprit is- what seems diversified, in real sense it is narrowly diversified. How?

BSE, Bombay Stock Exchange has about 7,000 listed companies. Astonishing, right? But, more surprising is 90% of mutual funds are invested in just about 500 companies (mind you, not in any particular order). Now you understand, the universe for any HDFC or ICICI or Birla Sun Life largely remain the same, which particularly holds true for large-cap because the rate of participation is high which reduces the return potential as mutual funds/ FIIs/ retail investors (like you, me and other individuals) readily invest in them. So, these large-cap stocks remain overpriced and overbought, hence garner average returns over medium term.

Here’s when, mid-cap, small-cap and sector-oriented pay for valuation, participation and earnings re-rating. Particularly, sector funds are direct beneficiaries of economic cycle like any banking-specific has earned 20% over and above any large-cap fund over the last one year (November, 2014).     

       

The call for over-diversification needs to be controlled and key focus should be to keep the core equity portfolio as per the economic cycle and your risk profile. Because, AMCs keep showering new schemes as per market condition to lure investors and the distributors will try to sell you the schemes in one form or the other. But, the idea should be to keep the allocation spread across equities, debt and international funds as per asset allocation.

I believe, a portfolio of total 8-10 mutual funds shall offer efficiency in holdings. Make sure your portfolio remains align to risk profile, financial goals and economy to reap in objective of long-term wealth maximization. Remain long-term focused on your portfolio because long-term benefits needs long time horizon as well.