Investment strategies that work the best

One of the most important questions that an investor should consider is "why invest?" We all invest for some reason, some objective, and some goal. As long as the reason or the objective is related to some financial goal in life, there is a quantifiable target. However, in many cases the goals are very vaguely defined. Consider these:

"I want to earn highest returns"
"I want maximum returns on my investments"
"Give me the best stocks or the best mutual funds"

These goals are so vague that they will eventually lead only to disappointment as finding the best investment avenue that will offer the maximum return is like finding the Yeti in the Himalayan mountains. Many have tried for years and many are trying, but nobody has found a real Yeti so far.

Answering the above question correctly is a very good starting point of investment planning.

Once the goals are properly defined, the second level of filter is to check if the goals are reasonable. There have always been three important questions:

� When to invest?
� Where to invest?
� How to invest?

Most of the time and energy are being spent on finding the answers to the first two questions.

Let us look at the first question: "When to invest?" The timing question is probably the most intriguing and tempting. However, years of efforts have ensured that most advisors have given up on this and most of them recommend SIP - the Systematic Investment Plan, which removes the element of timing.

The answer to the next question "Where to invest?" lies in finding the stars or the winners of the future. Well, it is another activity that many engage into. There are various methods adopted for the same. Often, many methods are devised after doing lots of back-testing and also running various simulations. The problem with such analysis is that it is entirely based on the past and often the things that coincide may not have any cause-effect relationship. Another problem with such analysis is quite unique to securities markets - the impact cost. While the number crunching suggests that certain strategy may prove to be profitable, the moment the investor attempts that the impact of the investor's action moves the price such that the profitable opportunity disappears. In many cases, the opportunity on paper just does not exist in reality after taxes and transaction costs. Add to that the risk of being wrong.

That leaves us with the last question of "How to invest?" I think this is the single most important question that financial planners should focus on. The answer to this question actually answers the first two questions as well. The how of investing is nothing but asset allocation, which is derived from the financial goals and the risk profile of an investor. And then from there you also get the answers to when and where. Whenever the investor has money, it is the time to invest and where to invest is answered again by asset allocation - it tells you the allocation to individual asset classes.

Economists Brinson, Beebower and Hood in their classic 1986 study "Determinants of portfolio performance" (repeated in 1991) concluded that "Asset allocation helps explain over 93% of a portfolio's performance."
With this background, let us understand the role of an investment advisor. According to me, an investment advisor is supposed to understand the needs and goals of the client and recommend appropriate investment strategy. The focus here is on the need of the client and not on the movement of market prices or identification of future winners. If the advisors focus only on the needs of the client and arrive at appropriate asset allocation, the next step is to identify the components. Having identified the asset allocation, the most efficient strategy would be to use low cost index funds for the respective asset class (as long as these are available). While active fund management can generate extra returns, it is almost impossible to identify the winners well in advance and consistently over long periods of time.

- Amit Trivedi

The author is proprietor of Karmayog Knowledge Academy. He can be reached at karmayog.knowledge@gmail.com