Saving for growth

Time and again we reinforce the point that for an investor looking to really grow their savings, one cannot afford to ignore equity-based investments. However there is another set of investors that ask questions such as: where should I invest my savings in order to make maximum gains from rising markets?

The straight and honest answer to this question is - we don't know, and in all probability, nor does anyone else.

There are two problems with asking this question. One, the person posing the question wants certainty; and two, they want the maximum possible gains. If they make 10 per cent during a rally and later discover that they could have made 12 per cent some other way, they consider themselves to have failed and the person who advised them to be a complete fool.

Let's take a moment and figure out what we mean by investing for growth. In simple terms, it means investing for the long term in order to grow your capital. Fundamentally, there are two ways of investing in a business. One is to lend money to it and the other is to own a part of it.

When you lend money to a business, your upside is fixed, although your downside is not. You are not going to earn more than what was promised to you, although if the business fails, you could end up losing your money. This is what you are doing when you invest in fixed-income securities or debt funds.

However, when you buy a business, you are part owner and share equally in the growth in value of that business. When that business does well and the stock market values it higher, you share that growth equally with co-owners of the business. All the upside of the business is yours, along with all the downside.

This is the core difference between investing for growth and investing for income. It is the difference between having your own business and lending to other businesses. It is self-evident that under almost all circumstances, business owners will make more money than lenders.

The question then is how exactly do you translate this knowledge into action.

In a rising market, investors are far more prone to committing sins of commission than sins of omission. Look at it logically - what does an investor do? He either sells or he buys. Can it be a mistake to sell during a bull market? Not really. Since there is a bull run on, it stands to reason that you are selling because you are booking profits, and so the worst that could happen is that you could make less money than the maximum possible. But it's far more likely that you'll buy something that is overpriced, or you'll make some big purchases that you shouldn't have and later regret them.

The converse is also true. In a bear market when investors stop their investments, in some cases sell them, in order to avoid losses, this hurts their potential of making long term gains by staying invested in equity. Instead, they realise losses which until then were only notional and inconsequential if the investment had remained untouched in the long run.

When it comes to markets, it is more important to have a good list of things that you must not do, rather than of things that you could do. Here are some that you may find worth reading closely:

1. Don't buy anything you can't understand yourself:
Before you buy an investment, understand how it works and why you are buying it. If you do not have the time or the skills to do this, hire someone. What we mean here is buy a mutual fund. It's okay to turn to a real expert, but always understand what you are doing.

2. Don't chase performance:
If you invest based on immediate past performance, the inevitable effect of this is you'll buy an investment when it is high and eventually get disappointed and sell it when it is low. Instead, choose funds that have proven themselves over different kinds of markets.

3. Don't ignore risk:
Human beings are overly averse to loss in some situations and less averse in others. We are often willing to take larger risks in order to avoid losses than to make gains or to avoid losing potential gains. Understand the risks you are taking and the potential impact of those risks getting realised.

4. Don't ever time the market:
Timing the market is not going to work most of the time. You must invest in a way that the current state of the market is irrelevant. One easy and effective way of doing that is to invest a fixed amount regularly through SIPs.

5. Don't hold on to losers:
We all end up sometimes investing in duds, whether stocks or funds. Once you realise that an investment is bad, there is no point in holding on to it. However, you need to be careful that you do not brand a fund a dud for just a small differential of performance.

6. Don't think you've missed an opportunity:
When the markets are rising, there is a rising sense of panic in your mind because you are missing the bus. And so you get a panic buying attack where you buy something, anything that looks good just so that you do not 'waste' this bull market. Don't do this. More money is lost in investments made during a bull market than at any other time.

Don't fret if you think you've lost an opportunity to make money. Instead, start preparing for the next time right now by choosing some good funds and start investing wisely and systematically.