July 23, 2024

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Expectation reduces Joy! | Personal Finance Plan

8 min read

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 heartburn 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. In a different office and with a different employer.

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.

This is true for personal relationships as well, isn’t it?

Why am I talking about this?

Because expectations are quite relevant for your investments too.

As an investment adviser, managing the expectations of clients is an important responsibility.

Before I start working with an investor, I 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?

A few investors answer “3 years”.

For your investment to double in 3 years, you need a CAGR of 25-26% p.a.

Not impossible, but not easy either over the long term, especially if you are investing in diversified mutual funds.

Recent performance (experience) affects return expectations. And at least in some of these cases, the answer is influenced by the market returns of the recent past. However, there is no guarantee that such performance will continue.

And the limited I have seen, the return expectations tend to get aggressive during good market phases.

This may be true for a lot of people

I am sure many investors have high return expectations when they are starting out in stock markets. In fact, that’s why they want to invest in stocks or equity mutual funds. To earn high returns.

And these return expectations may further get emboldened if they are starting during a bull market phase. Because that’s what they have seen since they started following equity markets. High returns.

Rising markets attract new investors. During good times, the perception of risk goes down. We may start believing that “risky investments” are really not that risky. OR that you cannot lose money in investing in stocks or equity funds. Hence, there may be an inclination to make riskier and bigger bets.

Such investors may NOT have studied markets’ history and historical returns. OR they may have missed out on the bull run over the last few years and want to make up for the missed opportunity.

Very high return expectations will only lead to disappointment because you are unlikely to be happy with returns. And that may push you into even riskier (or perhaps even less regulated) products.

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.

Good phases or bad phases do not last forever. The market trends will change with business cycles, sooner or later. There is 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 or invest directly in stocks

I hear this a lot during good market phases.

Again, nothing wrong. With stocks, you can hit the jackpot (if you get it right).

Your friends or colleagues may have made a killing on their stock picks. But never forget disclosures can be selective.

I do not want to discourage you from investing directly in stock markets. It can be highly risky but an extremely rewarding experience.

Neither do I doubt your ability to pick good quality stocks. You may have done quite well in your profession. It is quite possible that you can translate similar performance to stock markets too.

But it is NOT easy.

Can you go through the grind and put in the hard work? Do you have the requisite investment discipline and can put in the time required to select the right stocks?

During bull markets, stock picking may look easy, but it is not.

Picking up the right mutual fund for your portfolio shouldn’t take a long time. Picking up a good stock may require weeks and months of research.

Moreover, even when you have the skill, I believe managing a stocks portfolio requires at least 10X the investment discipline you need to manage a mutual fund portfolio.

You tend to have greater emotional attachment to the stocks you pick (compared to mutual funds you own). Booking losses is not easy with stocks. It is not easy with mutual funds either. However, MFs are diversified. The odds of an MF scheme NAV going to zero are quite low but this happens often with stocks.

You must learn to manage confirmation bias. You must know how to size your positions in the portfolio. You must have a plan to adjust position in the stock (reduce or increase position) depending on how your investment has played.  All this is not easy.

How do Irrational Expectations affect you?

You make bigger bets than you should. Deep down, everyone is happier with more money. When you expect high return from an investment, you will likely invest more there. More than you should. Conventional wisdom would require you to start slowly, test the waters and get comfortable before committing big capital. But you start with a very big investment. Say 25% of your net worth compared to 5% of your net worth.

You make Riskier bets: You started investing in diversified mutual funds expecting to earn 25% p.a. That didn’t happen. You moved to stocks to earn better returns. Couldn’t make it work.  Onwards to derivatives or even riskier investments like cryptos.

Note there is nothing wrong about big and risky investments per se. However, you must draw a line. Can you manage if you incur a loss? Have you considered that a “risky investment” is called risky for a reason? You can lose money.

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 or investments, even minor under-performance will worry you.

Investment discipline can get compromised, especially when you start comparing the performance of your portfolio with others. You may start ignoring the importance of asset allocation.

Shuffling investments in hope of better returns may lead to unnecessary costs and tax liability.

Focus shifts from your financial goals to returns.

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 2-3 years (as on July 6, 2024), 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 the year 10% down. You see and read about doom and gloom everywhere. You get rattled and stop making further investments, or worse still, exit your investments altogether. All of us know that’s not how you make money in stock markets.

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.

If you want to trade/time the markets for a high, segregate a small portion of your portfolio for this purpose.

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. Over the past few years, you must have heard ads about Rs 1 lac invested certain MF schemes turning to Rs 1 crore in about 20 years. Great but how many investors stayed the course (and did not sell)? 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.

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 incur a loss. Even for the broader markets, there is no guarantee that you will do well.

During accumulation phase, volatility is your friend. Rupee cost averaging (SIP in equity funds) can help you.

During decumulation phase (retirement or when you must withdraw from your portfolio), volatility can be your enemy. You are seriously exposed to sequence of return risk.

The post was first published in June 2017 and has been revised since.

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.

This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.

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