Are we our best friend or our worst enemy?

The title may evoke a lot of curiosity. It may look like a Jekyll and Hyde persona we are referring to. But we see that a lot with people, especially when it comes to their finances.

Most people say that they want to live a happy & peaceful life. They want to enjoy life while ensuring a comfortable future for all in the family, make sure that the goals are met on time and can retire comfortably. That portion is understandable.

But what most people end up doing makes one wonder if Hyde-side is taking over their faculties and sabotaging it all.

Since we deal with a wide variety of people, we have had the occasion to witness this from up close. In this piece, we discuss some such actions which are done with good intentions but end up as a lemon.

Too much focus on returns –  People think that high returns are essential on whatever they invest, at all times. Hence, they keep switching their investments from one to the other, often ignoring taxes and exit charges.

Look at this equation – 

Final Amount = Initial Investment *( 1+ interest ) ^ number of years

In the above formula, most focus on just the “interest”. But the actual outcome is also going to be determined by how much is invested and for how long one is willing to keep it invested. The Initial Investment & Number of years are hence crucial determinants in how high the final amount can be!

You might have realised that the above is just the compound interest formula!

Beginners luck – This is probably the worst thing that can happen to anybody.

As the name suggests, a layman investing and making money due to a rising market or pure chance, thinks that he is invincible and has a Midas touch. Due to this, the amounts invested over time go up, probably even pumped up with borrowings.

Eventually, the balloon is pricked and along with it, the ego and the investment kitty of the investor gets deflated. This has happened countless times in stock markets & real estate. Waiting to happen in Cryptos and startup investing ( done by normal investors). Sadim touch ( opposite of Midas touch ), people think, happens only to others, like death!

Market timing – Timing the investment seems to be a pet subject with most investors. They want to predict whether the market will go up or down and invest accordingly. They would also like to see if they can move to another asset which has started climbing.

But almost every knowledgeable finance guy agrees that it is impossible to predict market direction & the extent of up or down move. Also, no one knows the right point to enter.

How many people in the world had predicted that during Covid time the markets will be in a bull phase – from April 2020 till now? As far as I know – NONE!

Most had predicted that it would drop like a sack of coal! Many had withdrawn from the market and had waited in cash, failing to participate in the vertiginous rise of the market.

Trapped by conditioning – Some people have heard that certain assets are good or bad. However, if one’s parents have done well by investing in FDs and real estate, it does not mean it will hold good now. You cannot look for the cheese in the same place, for it has moved!

If one has made good money in real estate in a couple of investments, that does not automatically mean one can keep investing there and keep making money. But past learnings are very hard to shake off!

Sometimes, the early learnings about money which we call money scripts, can play an important role in one’s life. Also, someone may be favourably disposed or averse to some investment due to early life experiences. For instance, stock market aversion can be due to what they would have seen or heard in their growing up years.

Fear of losing out – This is a behavioural trait that urges a person to move in when some asset seems to be on the rise. One does not want to miss out on the “one-time opportunity” and the potential massive payoff.

The irresistible urge to move to an asset that is doing well now and to make a quick buck is a human failing called Greed. The alter ego of that is Fear, which makes a person very uncomfortable when the asset goes down in value or is volatile.

Acting on such cues, no one has made money.

MLM/ Ponzi scheme – Some schemes capture this emotion called Greed very well and have built products around that. People gravitate towards Multi Level Marketing (MLM) schemes as they are lured by the prospect of amazing earnings (on paper)! A small fraction at the top do earn well. Only that fraction is miniscule, like 1%.

Also, in their interest for returns, people end up with Ponzi schemes.  Here the returns given to an older investor comes from the principal of the new investor!

You would readily appreciate that this is not sustainable and will collapse. But, there are multiple such schemes running at any point and enough people to put money in each one of them.

The adage – Fools and their money are soon parted, may have come out of observing people investing in such schemes! But these people are quick to blame, the Government, RBI, lack of enforceable laws, tortuous legal system etc., never themselves!

The biggest Ponzi scheme was run by Madoff in the USA. His scheme had USD 50 billion when it went bust. He kept it on for over 20 years!

Action & Excitement – Many people look for excitement with their investments! People want to invest in assets that are trending which would also possibly be great conversation starters, in a cocktail party. Cryptos, Farm houses, Holiday homes, Real estate investments abroad, angel investments or investments in startups are all exciting icebreakers in a party and to showcase thought leadership! MFs & Bonds don’t stand a chance here!

The other thing investors look for is action. That is why they love stocks and hate MFs. There is so much action in stocks – one can even trade throughout the day. It is entirely another matter that day trading is not investment at all, but speculation!

Making up money lost elsewhere – When people lose money in some place, they want to make that up in the next investment! There is no logic to this – but we hear this fairly often!

The loss from a previous investment cannot be sought to be made up with a later investment. If one is hell bent on that, one may end up taking risky bets which will set up the investor for even more losses, in the current investment.

Every investment should make money – While we certainly want all our investments to make money – good money, it is fairly obvious that every investment may not. We need to focus on doing well at the portfolio level.

Sometimes, in a bouquet of investments, say Equities, investors do not want to cut their losses and invest in other equities that have a better chance of making money.

The reason – they do not want to book losses in that equity and want that stock to recover and give returns. Many do not understand that it is better to fold one’s hand sometimes and play the next hand well.

Tax aversion –  Many investors bristle when there is a tax to be paid – even if the effective tax in percentage terms is very low. This is inexplicable.

The tax on equity assets ( after a year of investment ) is 10% after a Rs.1 Lakh deductible on capital gains made. The tax on Debt MFs ( after 3 years ) comes to an effective 5%-7% approx., in many situations. But, this does not make much of an impression with investors.

The tax amount in rupee terms could still be big, eg. Rs.3 Lakhs tax on a Rs.55 Lakhs profit. There is no way to avoid this. But this comes in the way, when better investment options are available and could well have been availed.

We need to be mindful of what we do with our money. Our own prejudices, behavioural quirks and biases, past learnings that do not apply any longer, psychological failings, wrong inferences etc, ensures that we do not reach the potential with our money. 

We are mostly in the zone of what-could-have-been instead of being a helpful friend to ourselves. It is almost as if Hyde is in charge of our money most times!