If you ask 100 people about secret of successful investing, at least 99 of them will tell you to stay invested for the long term. When we get whatsapp forwards advocating long term investing and quoting a list of stocks which have delivered 100x to 1000x returns over last 15 and 20 years, we forget that there are 1000s of stocks which didn’t made it to this whatsapp list. What happened to investors who stayed invested in these stocks? Did they even got their capital back?
In investing survivorship bias has major influence, we like talking about successes and rarely about failures. We Quote rules and principals in hindsight as it is convenient and easy to prove historical data. But more often the future is distinctly different from the past. And rules set in hindsight may not necessarily accord you success. Long Term Investing is one such principle which suffers from survivor-ship bias and hindsight.
No matter what is happening in the market, stock or a mutual fund, the advice we often get is stay invested and everything will fall in place. To some extent long term investing has become a common excuse to hide our mistakes in investing. Long term investing is not easy as it is understood, in fact it requires more deeper study than needed for short term trading. It requires lot much activity contrary to what many of us believe.
Penning down some key principles that can be followed in long term investing in mutual funds.
Don’t chase the crowd: Often themes that are being chased are cyclical, even if they are not, investors optimism which is most likely followed by pessimism makes the theme/asset class cyclical. They are often overvalued and negligible margin of safety.
Diversification: Diversification is the most important pillar in long term investing. Diversification across low correlated assets will help you stay invested across different market cycles and not panic.
Keep watch on risk: If your focus is return and ignore risk completely, you may end up with wrong portfolio which can make you vulnerable during volatile markets.
Buy asset class not market outlook: Invest because you believe equities are best asset class not because market outlook is good for next 3 to 5 years. Market cycles can change overnight.
Being actively inactive: The most important element in long term investing is aggressively monitoring your funds and asset allocation. When markets are rising and amateur investors are doing very well, it’s easy to forget that protecting your assets during declining markets requires skill, discipline and constant attention. Investors need to expect and be prepared to react to fast-moving markets. No market rally is permanent and no decline lasts forever, meaning that there are no investments that you can buy and forget about.
Monitoring change in fund manager, mandate of the fund, major churn in portfolio, skewed sectoral bets, performance against benchmark, costs and themes the fund manager is playing are some of the elements which you need to constantly monitor. Being actively inactive means actively monitoring your portfolio yet be inactive and not doing unnecessary churn in the portfolio.
Mutual funds no more fill it, shut it, forget it:
Mutual fund is an easy asset class to monitor in the long term, at least looking at the past we can surely say this. We have seen how staying invested in funds launched in 90s have generated huge wealth. But in past when there were fewer funds to select the probability of getting it right was high, as we go ahead, there will be more number of funds with different themes and styles lowering the probability and making it difficult to choose.
Unlike in past fund mandates are not flexible making them tough to generate alpha after a certain size. Fund managers are changing as they have 40 different AMCs offering better pay checks. Due to business needs fund managers are taking more risk to generate front ended returns and shore up short term performance inducing more churn. Over last 10 years over 40% equity funds have underperformed benchmark and may continue to do so. Hence, it is important to actively monitor your portfolio and do required changes when there are red flags instead of simply saying long term investing will wash away all the sins. Don’t risk your hard earned money. If you aren’t ready to do this invest in an index fund or hire a good financial advisor.
Happy actively inactive long term Investing!