[This article originally appeared in Dignity Dialogue‘s January 2013 issue.]
Over the next few months we’re going to let you in on some of the secrets of Squirrel’s Corner – guidelines to make your investment life easier, more rewarding and a bit more fun.
This month’s mantra is Simplify.
What does this mean?
Here are some examples:
Bank accounts: Reduce the number of bank accounts you hold. We acquire bank accounts over the years for a number of reasons – our employer required us to open one in this bank; we used to stay there so we opened an account in that branch, then we moved here so we opened another one; we have a credit card attached to that one; and that other one is required because we have a locker there; and then there’s the one our kids use to send us money or (more likely) we use to send them money.
Take an unemotional look at your accounts and see if you can prune them to 1 or at most 2 bank accounts. It makes it easier to manage and track your funds. Close the ones you haven’t operated in months and make sure they’re not listed on any of your investments.
Signing authority: Ensure all your investments and bank accounts have both you and a trustworthy (can’t emphasize that enough!) other as an either / or signatory (not a joint signatory). That way if you’re incapacitated in some way, you still have access to your money.
Investments: There are two aspects to simplifying your investments.
The simplest one to follow is this: do not invest in complex or complicated products. Complex products often do not deliver what they promise and there are usually ‘catches’ and ‘gotchas’ in the fine print that will not make life easy for you. Use Warren Buffet’s mantra – if you don’t understand the business (read: product) don’t invest in it.
The second aspect to simplifying your investments is don’t over-diversify or fragment your portfolio. It’s pretty pointless having lots of small investments in lots of places. There are two reasons for this: one, is that managing lots of small investments is painful and error-prone; folios to update, bank deposits to check, and when you want to redeem, your money is scattered in lots of ‘pockets’ and taking it out is both frustrating and time-consuming. And, as a by the way, don’t complicate your life by holding some in single names and others in joint names and some with different signing instructions and so on – it’s murder keeping track of that kind of administration.
A more important reason to de-fragment is that fragmenting invites the law of averages down on your head. If you have a lot of investments, chances are that not all of them will do well at the same time, so the bad ones will drag the good ones down. Look at it this way: if you have two lakhs spread across twenty different shares (which is Rs.10,000 per scrip), it’s unlikely that all twenty will do well at the same time, and it’s even unlikelier that each will deliver spectacular returns. If a Rs.10,000 investment returns even 50% (highly unlikely) you only make Rs.5,000. If a Rs.2,00,000 investment returns 10% (much more likely) you make Rs.20,000.
What constitutes “small” or “fragmented”? Answer that question by reference to the proportion of your portfolio rather than in absolute term.
Thumb rule: don’t invest in more than 4 or 5 scrips or mutual fund schemes. Putting between 20% to 25% of that part of your portfolio in a single (sensible) investment is an acceptable risk and one that’s more likely to pay off.
(An important aspect of de-fragmenting is to allocate your portfolio correctly across low-risk investments (I.e., debt) and higher-risk ones (e.g., equity) – but that’s a topic worthy of another article all by itself.)
If you’re worried that 20% of that part of your portfolio is a large amount to entrust to a single investment (“will they pay me back when I need it?” “is my money safe?”), then stop worrying. The better mutual funds, for example, manage thousands of crores of rupees, so even if your investment in them is in crores, it still constitutes a small enough percentage that they would have no problem paying you back if you want them to.