One of the few things that I remember from induction training on the first day of my professional career many years back is a quote from a presenter that Expectation reduces Joy.
From the perspective of a large software company, it was important to have employees with not too high expectations. However, even as an employee, it made a lot of sense.
Your expectations about salary hikes and promotions may be out of line. And that will only result in heart burn and lower productivity. You may end up harming yourself more. Needless tension will only affect your health and performance. It may be a better choice to pack your bags to go to another company to work.
Remember, if you do not change, this cycle will only repeat itself.
I do not mean that you should not aim higher. Aim for the sky. Nothing wrong with that.
However, the expectations must be rational.
And this is true not just for employer-employee relationship.
Isn’t this true for personal relationships too?
Why am I talking about this?
Because expectations are quite relevant for your investments too.
As an investment adviser, managing expectations of clients is an important duty.
Before I begin working with a client, I tend to ask a few questions about their risk taking ability, risk appetite and return expectations.
One of the questions is:
In how many years do you expect your money to double?
Answer: 3 years.
I get this answer from quite a few of my clients (not all). Many such investors are first time investors.
For your investment to double in 3 years, you need a CAGR of 25-26% p.a.
Clearly, on the higher side. I guess their answer is driven by looking at the performance of the best performing funds in the last three years (as on June 12, 2017), especially in the mid and small cap space.
Many such funds have doubled money in the last three years.
However, that does not mean such performance will continue?
To the contrary, if you believe in regression to mean, the funds should not perform as well.
This may be true for a lot of people
My clients do not come from Mars. I am not a statistician but I think they make for a good sample set. I am sure many other investors too have similar expectations from their equity investments.
To my surprise, there are quite a few who were happy earning 6-8% p.a. in their fixed deposits for many years (or even decades) but now even 15-18% p.a. is on the lower side.
This is typically the lot who has missed out on the bull run over the last few years and want to make up for the missed opportunity.
You need a risk premium for the volatility you will experience in equity markets. However, that does not mean you ask for a 20% higher return?
Very high expectations will only lead to disappointment because you are unlikely to be happy with returns.
By the way, I am not saying that you should expect 15-18% p.a. from your equity investments. You should expect much less, more in the range of 10-12% p.a. over the long term.
The nature of the product does not change because you invested in it or after you started investing in it.
Markets will not run up just because you started investing.
Equities will be quite volatile irrespective of whether you invest or not.
Debt investments will be less volatile than equities whether you invest or not.
Traditional life insurance plans will provide poor life cover and low returns irrespective of whether you purchase such plans or not.
Therefore, why should your expectations be out of the ordinary?
As they say, This too shall pass.
Good phases or bad phases do not last forever. The market trends will change with business cycles, sooner or later. Nothing you can do about it.
The best you can do is to acknowledge this fact and to ensure that you are there when the markets run up the next time.
I want to start trading
I get regular calls from my clients asking about the best trading and demat account. Because they want to start trading in “small amounts”.
Needless to say, such queries increase when the markets have run up quite a bit in the recent past.
Their cubicle mates may have made a killing on their pickings. And with direct equity, you can hit jackpot (if you get it right). For all you know, they could be mistaking luck for skill. Moreover, never forget disclosures could be selective. They don’t want to miss out.
In no way, do I want to discourage my clients to invest directly in stock markets. It can be highly risky but an extremely rewarding experience.
Neither do I doubt their ability to pick good quality stocks. All of them have done quite well in their respective fields. Quite possible they can translate similar performance to stock markets too.
But, can they go through the grind, the hard work or the discipline and the time required to select the right stocks for themselves? There is no free lunch, after all.
Legendary value investor Warren Buffet didn’t build Berkshire Hathaway watching CNBC or trading on tips from friends.
Such envious record is built on the bedrock of sharp investment acumen and an unflinching investment discipline.
Now, these clients didn’t have time to select the “best” (or the right) mutual funds for their goals but they think they can find time to research the right stocks. Only they can answer.
Picking up a right mutual fund for your goal shouldn’t take more than 5-10 minutes. Picking up a good quality stock may require hours, days, weeks and months of research.
By the way, I didn’t say the “Best” because there is no such thing as the Best.
There is no way to figure out that a particular fund will be the best fund after 10 years. At least I do not know. Of course, there will be a fund (after 10 years) that would have given you the best returns over the last 10 years.
The problem is how to figure out today which fund is that. If your pick somehow ends up being the best, how can you be sure that you are not mistaking luck for skill?
How do Irrational Expectations affect you?
- You lose your sleep: The best investments for you are those that let you sleep peacefully at night. However, if you are chasing the best funds for that extra percentage point of return, even minor under-performance will worry you.
- If you keep discussing and comparing performance of your portfolio with your friends, it is human behavior to a bit jealous if your friends’ portfolios have done better. You compromise your quality of life.
- Remember, most investors only brag about their winners and tend not to speak about the losing picks.
- You keep chasing the best funds. This may lead to unnecessary cost and tax liability.
- Investment discipline is compromised.
- You may start ignoring the importance of asset allocation. After all, you want to ride to the top.
- Focus shifts from your goals to returns, which makes no sense.
- You will keep chasing the latest fads in the markets. For instance, long term bond funds will show great past returns if you have been through an interest rate down cycle. If you focus only on the past performance, you should pick up such funds. However, doing this at the end of down cycle may not be a good idea.
- If the midcap and small cap funds have done well over the last 3-4 years, you may be inclined to shift from large cap funds to such funds, irrespective of suitability.
- You may lose faith in markets quite quickly. You started with expectation of 25% p.a. and ended up the year 10% down. You see and read about doom and gloom everywhere. You get rattled, exit after booking the loss and go back to comfort of fixed deposits. You will come back after the next bull. Many retail investors do this. No wonder, many struggle to make money.
Keep this aspects about investments in mind
You do not control how much returns you will get. But you can control how much you invest. If you have lower return expectations, you will automatically invest more to reach your goal, thereby increasing your chances to reach your target amount on time. If you earn better returns, consider yourself lucky.
We overestimate our ability to time the markets and underestimate the importance of investment discipline. I must confess I try to time the markets quite often but more often than not end up looking like a fool.
If you want to trade/time the markets for a high, segregate a small portion of your portfolio for this purpose. That’s what I do.
Investment return is not investor return. We have heard many stories that if you had invested in a Wipro or Infosys in early 80s or 90s, your Rs 10,000 would have been worth hundreds of crores. Recently, a prominent fund house went gaga saying Rs 1 lac worth of investment became Rs 1 crore. How many investors earned such returns? Clearly, investor behavior plays a role.
If you are a new investor and in accumulation phase (not withdrawing money from your portfolio), the amount of investment is more important than where you invest. Suggest you go through this post on four phases of Retirement planning. Of course, I do not mean that you should start investing large amounts in traditional life insurance plans.
Read: What should you worry more about? Your next SIP installment or your Existing Corpus?
No matter what you are told and how you invest in equity markets (mutual funds or direct equity or through SIPs), there is always risk of loss in equity markets.
There is empirical evidence that suggests that the chances of loss go down if you invest for the long term but that is for broader markets. With direct equity, you can hold on to a loser for a hundred years and still sit on a loss.
By the way, even for the broader markets, there is no guarantee that the history will repeat itself.
During accumulation phase, volatility is your friend. Rupee cost averaging (SIP in equity funds) can help you.
During decumulation phase (retirement or when you have to withdraw from your portfolio), volatility can be your enemy. You are seriously exposed to sequence of return risk.
I say this because I see a many retired investors wanting to put a significant sum in equity markets after the markets have run up quite a bit. A few years of bad returns, they are looking at many years of financial misery.
Book Suggestion: Can I Retire Yet? How to Make the Biggest Financial Decision of the Rest of your life? (Darrow Kirkpatrick)
2 thoughts on “The Problem lies not with the Investment but with Investor Expectations”
what a wonderful and informative article. Loved it. Want to know what is accumulation phase? Is the fund with lowest standard deviation possible a good choice who are risk averse who dont want portfolio down by 10-20% anytime during tenure of say, 15 years, Can you suggest any equity fund with such low standard deviation for 10-20 years? how about equity savings funds who has 20-40% only in equity, still a equity fund for taxation?? can you suggest? also how to have a discipline for mutual fund investment? for PPF, its lumpsum 1.5 lakhs, SSY its lumpsum 1.5 lakhs, VPF- employer cut it systematically, how to do lumpsum in this high market? how to do discipline investment in mutual funds?
National saving scheme (NSC) is better and discipline problem free. invest 10 lakhs today after 5 years, take 15 lakh. so simple and soothing..how to do same in mutual funds? any mutual fund which give 16 lakhs after 5 years, if i invest 10 lakhs today, ?? please suggest? i know its not there. i just hope may be there is one?