What not to do in 2011

It is almost a truism that most people need basic financial literacy and it’s generally assumed that this literacy must take the form of knowing what to do with money. However, the truth could be exactly the opposite. It would be far more useful for people to instead learn what not to do with their money and this education is not available anywhere.

We try to list here below some don’t dos for you for 2011. The idea is enable you to do few right things and prevent you from making big mistakes. Jaago investor jaago……

Thou shalt not blindly buy high return products

One thing that frauds like the one at Citi bank may have taught us is that there cannot be any investments without “risks”. Promise of high return without commensurate higher degree of risks is just not possible. Structured products are good only if you invest after understanding it. Else avoiding them will not prove to be disastrous to your hard earned money! Follow KIS----keep it simple

Thou shalt not leverage

There can be products that although pass the test of legality, are best to avoid. Consider an investor who prefers to invest in blue chip stocks and prefers to hold them for long term. Such an investor will invariably be brain washed by his friendly broker to leverage his holdings by investing in derivatives. We have come across brokers who try to impress upon their clients that holding on to blue chip stocks for long term is a foolish thing to do, since the client misses out on the massive returns that can be his. The client will be encouraged to trade in derivatives and take home the high returns that derivative segment supposedly offers. The client becomes aware of the risk part of the derivative segment but only after it is too late—the client invariably loses not only his blue chip holdings but also his faith in the market and its intermediaries. The client is gone for good.

Thou shalt buy term insurance

It has been proved that Indians are under-insured. We do not have enough cover. Term insurance is hardly ever recommended by your “family insurance agent”. This is because an endowment or ULIP will fetch them far more commission that a term insurance policy. That term insurance is the basic financial product that everyone should buy in big numbers is understood but rarely followed. One of the basic principles of financial planning is that your family’s future should first be secured by way of adequate insurance coverage—term insurance in other words.

For the investor, not doing the wrong things should actually be learnt before doing the right things. Unfortunately, this is something that they’re likely to learn the hard way

Fear, Greed and Panic

Over the last few days, the standard investing punditry that is available on business TV and newspapers has turned fiercely negative. The consensus view is that we're doomed. The line-up of problems that are going to ruin us all is impressive indeed. Not only is the inflation rate rising, but so are inflationary expectations and that's supposed to be worse. There is a genuine fear in the air that growth is slowing down.

Among people who to invest in equities and equity-based mutual funds, the natural question to ask is what they should do now. In response, the best thing I can think of is to quote the great investor Warren Buffett. Buffett is fond of saying that one should be fearful when others are greedy and greedy when others are fearful. It sound like such an overly cute thing to say that you may feel that it's good only for printing on inspirational posters but actually, like everything else that Buffett says, it's deeper than it looks.

Clearly, others are fearful now. Does that mean that it's time to be greedy? It probably is. In one of his interview he had said something very interesting in response to a question about what investors should do now that stocks have started declining. Here's what he said. “The answer is you don't want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that (a) if you knew what was going to happen in the economy, you still wouldn't necessarily know what was going to happen in the stock market. And (b) they can't pick stocks that are better than average. Stocks are a good thing to own over time. There are only two things you can do wrong: You can buy the wrong ones, and you can buy or sell them at the wrong time. And the truth is you never need to sell them, basically. But they

could buy a cross section of American industry, and if a cross section of American industry doesn't work, certainly trying to pick the little beauties here and there isn't going to work either. Then they just have to worry about getting greedy. I always say you should get greedy when others are fearful and fearful when others are greedy. But that's too much to expect. At a minimum, you shouldn't get greedy when others get greedy and fearful when others get fearful”.

Just change 'American' to 'Indian' in these words and then read them carefully. It's so far removed from what most people think investing is all about that it takes time to figure out what this amazingly successful old man is saying. What he is saying that long-term success of investing is based not on the fact that the investor will be able pick the 'little beauties' but on the fact that country's economy is going to grow. What is happening now, (the short-term news flow) is not important because regardless of what you hear, what is happening in the country and the economy in the short-term may not be a good indicator of what is going to happen in the stock markets in the short-term. There are too many factors, too much noise, that affect the markets for the average investor to figure out.

Another factor that can contribute to increase in your wealth is your ability to macro manage your investments and not micro managing our investments. We are so obsessed to micro manage our investments that more often than not we tend to ignore the bigger picture. The bigger picture is that our economy is growing. There may be differences about the growth rate, but there’s no denying the fact that we are growing! Even at say 6% p.a., we are one of the fastest growing economies in the world. This growth is sooner rather than later, going to be reflected in the corporate earnings and hence in their stock prices, as stock price is a slave of earnings. Our obsession to time our investment with movement of Sensex or Nifty is faulty also on the ground that they do not reflect the total picture. 

However, in the long-term all the noise gets cancelled out and you are left with one single question. Is the country's economy going to grow? If you think the answer is yes, then that's a good reason to go ahead and own a broad cross-section of stocks. The bonus is that because it is a time when others are fearful, a lot of investments are 

cheaper than they were just a short while back.

Let me prove it with facts. To do it we will have to go back in time.

Past-looking
I turn to history and begin with the growth rate in the Indian economy as defined by the growth rate in India’s GDP.

The data indicates that - over the 28 year period from 1980 to 2007 - the rate of growth in real GDP was 6.2% per annum. The "real" means after inflation - after the fake increase in wealth caused by an increase in prices.

I add back inflation - which averaged about 7% for the past 28 years. This allows me to get a sense of how the Indian economy grew at "nominal" prices. Combining the two, I broadly see that the Indian economy grew by more than 13% every year for the past 28 years. Not bad, considering that we had a closed economy all this while, with under performing public sector.

And the BSE-30 Index increased by 18% every year since 1980.

That is the past.

This growth has come inspite of the famines, wars, assassinations, bankruptcy of our economy et all. Is there anything to suggest that the next 30 years will be different from the last 30 years?

It took us nearly 60 years to become $1 trillion economy---it’s going to take only 5-6 years to double it going forward at the present growth rate. Are we going to let this milestone pass just because Sensex/Nifty gyrating to temporary news flows—and in the process ignoring the inherent strengths in the economy??