In my meetings with prospective clients, friends etc., topic of investing invariably comes up. I am a big proponent of investing in equities especially for long term goals and some people say that they are afraid of investing in equities as they believe it is too risky.
I think it right for people to be “concerned”/“fearful” about investing. Any investment is a bet on future outcome, this makes returns uncertain, hence risky.
I was reading about NGO’s trying to make some difficult decisions, for instance – to effectively prevent malaria, should they give out mosquito nets for no cost, should they subsidize them or should they sell them at market price. In this day and age, where collecting data and analyzing it has become very easy, they have started conducting “experiments”. They select areas that are far apart and try out various options and check of the effectiveness of those options. In case of mosquito nets, selling them for a small price was found to be the most effective option to reduce incidence of malaria. Reasoning could be that people are more likely use a mosquito net if they have paid something for it. The one received for free may not used as recipient did not have a personal stake in it. Similarly, people conducted experiments to figure out if mid-day meals helped in keeping kids in schools – the answer in this case is, yes it did.
In this day and age of easy availability of data and analysis tools, many of our beliefs/hypothesis can be tested based on available information or experiments could be conducted to validate or disprove beliefs. Challenge would be when one is not ready to look at data to validate beliefs or if one is ready to ignore data because beliefs are too deep rooted.
Let’s discuss examples where I think the beliefs are fairly deep rooted and there is a significant denial or refusal to look at evidence.
Purchasing gold jewelry as an investment.
Purchasing gold itself could at best be considered a speculative activity –there are a lot of articles that suggest that the long term returns have been poor.
Considering jewelry as an investment is an open and shut case. Jewelry loses over 25% of its value the moment it is purchased hence it cannot be called as a reasonable investment. It needs over 33% appreciation just to break even.
Purchasing jewelry is an indulgence and it is ok to indulge oneself, but it is a folly to call one’s indulgence as an investment.
Purchasing homes using borrowed funds.
There is a lot of information and analysis questioning homes as the wealth creation vehicles for home owners.
Purchasing homes with long term debt makes it far more difficult to classify as an investment. In the last decade, someone who took out a home loan would pay an EMI of about Rs 1,000 for every lakh (100,000) of loan. If one wanted to buy an annuity that pays Rs 1000 a month, they would have to purchase an annuity that cost more than 1.5 lakhs.
- If a person wants Rs 1 lakh he has to pay Rs 1,000 a month
- If a person wants Rs 1,000 a month then he has to pay Rs 1.5 lakhs
A buyer who is purchasing her home using long term debt is paying over 50% premium at the time of purchase. This means over 50% appreciation is required to just break even, which makes it a poor investment.
This is far more adverse for people for whom their house represents a significant part of their net worth. They are not only overpaying but also their assets are not diversified and any event risk can significantly impact their financial wellbeing.
Investing in mutual funds.
Similarly there is enough information available to show that almost all mutual funds have lost to stock market indices, especially in the long term. In spite of this, assets under management of mutual funds is 20,000 times the assets under management for Index funds.
For most part information required to make many investment decisions is already available and all it needs is a desire to verify ones beliefs. We think it is ok to be fearful when one is investing as making any investment has some degree of risk. One should use fear as a driver to do some research and analysis. Fear should not drive one away from looking at data as this will have a high chance of leading to poor outcomes.
In investing, there is nothing to fear but the fear of looking at data to validate ones beliefs.