The Hindu Business Line : Financial Gita

Partha hurriedly rose from his seat and said: "Sorry, I didn't see you coming in. Yes, I am thinking of investing but it's all so puzzling. Should it be in CDs, or money markets, or bonds?"

Gopala said, "Arjuna, thousands of years ago while we were on the battlefield, I told you `One should not expect returns from actions; one should only perform one's duty.' Well, it is now 2005 and when it comes to investing, you should expect good returns.

"Anyone who wants to invest in public companies has a couple of choices. Either invest in stocks directly or in mutual funds. Stocks are one type of investments where you invest in a company and expect the company to do well in the future. Mutual funds are run by certain firms that collect money from the public and invest in different stocks."

"Okay! Which is better? I thought I had a tough time choosing between Karma-yoga and Karma-Samnyasa," said Partha with a laugh.

Krishna began, "They both lead you to the Supreme; in this case both mutual funds and stocks lead you to riches. Say, your son, Abimanyu, is interested in sports. He has two choices, either play in a team sport like cricket, basketball or opt for an individual sport like golf or tennis."

Krishna said, "Yes, what can a good player do in a mediocre team? India has always had talented cricket players but as a team we have not been able to achieve great returns. It is not enough if some players are talented; the team has to be excellent.

"A mutual fund is like a cricket team. The mutual fund manager invests in individual stocks and provides the collective returns to the investors. But it is nearly impossible for all the stocks in a mutual fund to provide stellar returns.

"Thus, the good returns provided by individual stocks are suppressed by poor returns by average stocks; hence the mutual funds have provided an average of only 11 per cent return in the last three decades."

Krishna continued, "The most common mutual fund is Vanguard 500 index which invests in all companies that are part of Standard & Poor (S&P) 500. So if you invest $1,000 in it, the money is split and invested in five hundred different companies. This is perfect idea if all the 500 companies provide good returns. Unfortunately, there are only a few good companies."

Arjuna said, "O great one! Can you explain this with examples of two companies that belong to S&P 500?"

Krishna went on, "You must have heard of Starbucks (SBUX), the coffee store chain, and Andrew Corporation (ANDW), the maker of Cables. Now, an investment of $10,000 in Starbucks would have become $110,000 in ten years, but the same investment in Andrew Corporation would have become only $4,200, which is a loss of nearly $5,800. A great investment provided by Starbucks is overshadowed by the loss of Andrew Corporation."

Arjuna asked, "Is it like when Rahul Dravid delivers a great knock, and the bowlers disappoint us?"

"Exactly. Take Tiger Woods, for instance. His success solely depends on his skill and fitness.

"So an individual who has an acumen for investing in stocks always fare well. The better you are in picking stocks, the better the returns!

"For example, an investment of $10,000 in 1970 in Wal-Mart would have become $13 million now. The same investment in the S&P 500 index fund would have become only $160,000.

"However, stock-picking is a science. It requires learning the right techniques. Not every stock that you invest in provides good returns."

Arjuna said, "You once said, `One who abandons duty merely because it is difficult, or because of fear of it, does not get the benefits'. Similarly, unless you master the science of picking stocks, you don't get the benefits. I think that is why very few people are good at it.

"If stock-picking is not your major interest, then isn't investing in mutual funds a wiser option?"

"It is," said Krishna. "A mutual fund manager invests your money in a variety of stocks. This diversification is to ensure that all your investments are not in one stock. To understand the difference between investing in a stock and mutual fund, let us look at the company called Eaton Vance.

"Eaton Vance specialises in running mutual funds. Investors who purchased $10,000 worth of Eaton Vance stock on December 31, 1979 (assuming they reinvested all dividends) saw it grow to $10.6 million 25 years later, according to Eaton Vance's 2004 annual report.

"The same $10,000 investment in the company's flagship Eaton Vance Tax-Managed Growth Fund (CAPEX) made at year-end 1979 was worth about $209,000 as of December 31, 2004 (assuming all distributions were reinvested)."

Arjuna said, "What are the techniques to go about picking the right stocks?"

Krishna answered, "The right stocks can be picked by using `fundamental analysis' or `technical analysis'. Fundamental analysis is like planning the entire war. If your strategy is to hold the stocks for a long-term — more than a year or two — then fundamental analysis is the right approach. It offers solutions to identify companies that are undervalued and poised to grow in the long-term. This is one of the common techniques and is adopted by legends such as Warren Buffett, Ben Graham and Peter Lynch.

"Technical analysis is like Padma Vyuha. You should know when to get in and get out. If your style is to invest for the short-term and get good returns, go for technical analysis. It offers answers to questions such as: When should one enter into a stock, is the stock is likely to go higher or lower in the short-term, and, if it goes up, what is the maximum value it can fetch?

"Both approaches have merits and demerits and an investor who wants to invest in stocks directly has to master both of them to profit well."

Arjuna prostrated before Krishna and said, "I am not sure if I can pick the right stocks; but I have done well in picking you to be on our side in the war, and now to answer my financial queries."

Racy@thehindu.co.in

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