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Native American lessons to equity investing

LiveMint logoLiveMint 02-06-2014 Kalpen Parekh

It was autumn, and the Native Americans asked their new chief if the winter was going to be harsh or mild. Since he was new to the role, the chief didn’t know the answer. But to maintain his authority, he replied to his tribe that the winter was indeed going to be very cold and that the tribesmen should collect wood to be prepared.

But also being practical, the chief secretly called the weather department for expert advice. “Is the coming winter going to be cold?”.

“Yes, it looks like this winter is going to be quite cold indeed,” the meteorologist at the weather service responded.

So the chief went back to his people and told them to collect even more wood. A week later, he called the weather department again. “Is it going to be a very cold winter?”

“Yes, it’s definitely going to be a very cold winter,” said the weather forecast man. The chief again went back to his people and ordered them to collect every scrap of wood they could find.

Two weeks later, he called again. “Are you absolutely sure that the winter is going to be very cold?”

“Absolutely,” the man said. “It’s going to be one of the coldest winter ever.”

“How can you be so sure?” the chief asked.

The weatherman replied, “Our sources tell us that. The Native Americans are collecting wood like crazy and that’s an indication of a very harsh winter.”

This is a story of how predictions are made; for weather as well as markets. And since not all predictions become self-fulfilling, investors need to have a better plan than relying on predictions of future levels of market. This one-and-a-half decade of the 21st century has seen many up and down market cycles and the next decade will be no different. Despite the volatility, the last 15 years have made money for a small minority of investors. What worked for these winners? The simplest rule was on predictions and it says: no predictions, only process. What process is this that got them a 15-year annual rate of return in excess of 12.9% compound annual growth rate (CAGR). Again the answer is not rocket science or a Black-Scholes equation. It is asset allocation, or the strategy of ensuring that the best performing asset class is always a part of your portfolio. This is important, because left to ourselves, we chase the best performing investment of last five years, which is rarely the best in the next five years. And the way they action their plan is to use regular systematic investing and not a sudden rush into the market. They do this using systematic investment plans (SIPs) through the ups and downs on the market. These time-tested rules are instructions that the majority loves to ignore and the minority quietly follows.

The reason to invest in equity right now is not the stable mandate to the new government (this hopefully will be a bonus), but the fact that over long periods of time the asset allocation approach actioned through an SIP has created wealth for the common man. The behaviour of majority is to wait for “acche din”’, “certainty” and the “right time”, but unfortunately good times rarely give good prices. The best prices are got when times are bad. So forget about watching the indices. Invest now. But invest for the long haul.

The author is chief executive officer, IDFC Asset Management Co. Ltd.

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