Keep return expectations moderate

We have observed several individuals who strove for perfection with their investments but gave up because of mental exhaustion and ended up with underperforming portfolios. In this article, we will discuss, applying psychology, philosophy and finance, and provide an answer to why mediocrity is effective when it comes to achieving your financial goals.

Skill or Luck?

Many of you prefer to have top-performing investments in your portfolio. And why not? All of us prefer more money to less, whether for buying a house or for spending in our retired years. The issue, however, is finding top-performing investments. You have to acquire the skill to consistently pick low-risk high-return assets or funds. Or you should have the skill to identify advisers who can pick such assets. Now, the former is difficult to acquire, especially if you do not belong to the asset management industry. And the latter is no less easy because you cannot choose your adviser based on his or her past experience alone.

How do you know whether your adviser delivered high returns to her clients out of luck or skill? You will face the same issue when you choose active funds based on past performance. A skilled portfolio manager or adviser can experience bad luck. Likewise, a not-so-skilled manager or adviser can have good luck. And you cannot easily differentiate the two! So, you need to clinically evaluate portfolios to test the sustainability of out performers, which requires time and effort.

Even then, you risk choosing the wrong fund, stocks or adviser, meaning your portfolio’s performance may be lower than that of the benchmark index (Nifty, for instance).

Why assume the risk, given that your objective is to achieve a financial goal, not to beat the benchmark?

Mediocrity and contentment

You are more likely to be content when you strive for mediocre investments than when you focus on earning higher returns! The reason is two-fold. First, consider the psychological factor. Your objective of selecting active funds is to beat the benchmark index. Your expectations are high.

Your regret willbe high, if actual returns fall short of expectations. Of course, it is moot if actual returns will be lower. But the point is this: The pain that you will experience when actual returns fall short of expectations will be much more than the pleasure that you derive when actual returns are higher than expectations. Do you want to suffer the regret?

Second, consider the philosophical factor. You need to do a lot of research if you want your investments to earn higher return than the benchmark. Your efforts will be no different, whether you choose to invest directly in equity and bonds or whether you buy mutual funds (directly or through an adviser). Your research time will cut into your leisure activity.

In a survey conducted recently, most elderly individuals regretted not having spent more time during their prime working years for leisure activities. None of these elderly individuals seem to have regretted about not working harder or spending less time over their investment decisions! So do you want to spend your leisure time, pouring over stacks of financial data in the hope that you will outperform the market?

Asset prices move due to factors beyond your control. You should, hence, adopt simple rules to manage your money — systematic investments in index funds, for instance. Your savings, not your ability to outperform the market, play an important role in achieving your goals. So, reduce your time and effort in taking your investment decisions. Mediocrity may not be best way to achieve your financial goals, but it can be effective and less stressful.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to >knowledge@thehindu.co.in)

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