The HoD of ITM Business School Prof. Krupesh Thakkar took a session on making wise investment decisions primarily when someone is spoilt by choice.
We always have to make decisions that define our fate. These decisions should be made ideally by wise choices, but often we choose our alternatives by compulsion or, worst, by leaving it to chance. The same is true for investments.
We invest in fulfilling our short-term and long-term goals ranging from buying a house, marriage, children's education, and a car to securing our retirement and achieving financial security. Hence, it is paramount that we make our investment with the utmost care and prudence, with due research, and by making a wise choice rather than random picks or following a bandwagon.
Investment Choice is not only about selecting the right mix from various investment alternatives but also includes the decision regarding the amount to be invested, the time horizon, and the frequency of investment (regular or lump sum). In an era where one is exposed to a plethora of information and investment avenues, one can indeed feel perplexed and make mistakes in their choice of investments.
So, how do you make these wise choices? The following pointers can act as a quick guide.
1) Choice between and among Asset Classes: Asset allocation involves dividing your investment among various asset classes. The traditional mix has been equity, fixed-income securities, and gold. This mix has become more complex with the evolution of new asset classes like commodity, international equity, currency, real estate, derivatives arts, collectibles, and alternative investments. The proper asset allocation depends on various parameters, which are further mentioned below.
2) Choice between Umbrella Investment vs. Goal-Based Investment: The umbrella investment has a single portfolio for all the life goals. But it is dangerous to have a single portfolio as any downfall can jeopardise the most important goals too. One needs to understand that there are no universal plans which fit everyone. The investment choice should depend on individual goals, its importance, time horizon, unique circumstances, and on the investors' risk appetite. And for each of these goals, there should be a separate portfolio.
3) Choice between Passive and Active Investment: A common puzzlement one encounters the choice of passive and active investment. Passive Investments, on one extreme, are the strategies that mimic the broader benchmarks. In the case of equities, the passive instruments are equity index funds and exchange-traded funds. Active Investments, on the other extreme, are the strategies that involve timing the investments and selecting suitable investments that require specific skill sets. Again, these two strategies can be used in synchronization. If one wants to opt for active investment, one can hire experts or act alone. Or, if one does not possess the skills, time and energy, he could go for passive investments.
4) Choice between Direct and Pooled Investment: The fantasy among some investors always have been to become overnight rich by investing directly into equity stocks. On most occasions, these investors end up on the losing side as they either invest in the penny stocks or the stocks they know little about, or they lack the skill sets to choose the right sector and stocks. That does not mean the direct equity is not a good investment. It is indeed, if invested with proper research or expert advice, for a reasonable period with patience and required discipline. However, many investors now prefer the pooled investment vehicles and mutual funds. Today mutual funds provide a wide range of products across asset classes - equity, debt, gold, and hybrids, for various motives – capital growth, capital protections, regular income, tax planning and with several investment options – SIPs, lumpsum, STPs, switches and SWPs. Depending on their return and risk appetite, one can choose among these mutual fund plans, of course, with or without the help of financial planners.
5) Choices among emergency funds: Today, we are aware of the need for emergency funds (required to meet at least 3-6 months' household expenses) when faced with bad weather. However, one still restricts oneself to saving accounts and fixed deposits for these emergency funds. But one can also opt for liquid mutual funds, arbitrage funds and short-term debt funds to fetch better returns.
6) Choice of Portfolio Insurance: In an attempt to reduce the unsystematic risks (risk specific to particular sectors), many investors diversify their portfolios which is indeed a good strategy. However, diversification, in turn, increases the risks and reduces the return. Another strategy a few investors employs is using derivatives to reduce systematic or market risks. This choice is practical, but if implemented without the required knowledge, it can even erode your core portfolio.
So, the problem of 'the paradox of choice (which means too many choices rather than giving happiness, giving anxiety and stress) can be addressed by streamlining our thinking to rationality to make a proper choice.
