Have you ever tried an unrated, unreviewed product while shopping online? The answer, probably, is an obvious NO. It is a known fact that customers are influenced by ratings and reviews. But not all reviews are totally reliable, and, at times, some of them can be fake, too.
We under-estimate the role of social media in influencing our beliefs and preferences. When we are constantly bombarded with similar kinds of information through different mediums, we tend to believe that they must be true and we develop biases.
As the biases gradually get ingrained in our minds, we repeatedly rely on them to form our decisions, even investment decisions. You may have frequently read about some common investing notions endorsed by self-proclaimed experts on social media. Let us debunk a few of them.
Age rule for equity allocation: One of the common investing tenets is that lower the age, higher the risk-taking appetite. This is what the 100-minus age thumb rule implies while allocating equity in the portfolio.
For example, if an investor is 30 years old, 100-30, which is 70, would be his ideal equity allocation in the overall portfolio. Consider two individuals, both aged 35. One is salaried, has a working wife and a school-going kid. The other is self-employed with erratic cash flows, has dependents -- a homemaker spouse, two small kids, aged parents and has a home loan.
When it comes to taking risk through equity investing, it is obvious that the 100-35 rule does not apply to both individuals. Both cannot have a blanket 65 percent allocation to equities.
Besides age, the asset allocation of an investor needs to be determined in conjunction with his goals, investment time horizon, financial situation (income & savings), liabilities, number of dependents and his/her risk-taking appetite, based on past investment behaviour and preferences.
It is thus imperative for investors to understand that the age factor considered in equity allocation is just a thumb rule and need not universally apply to everyone.
Avoid NPS due to long lock-in and annuity: As per the withdrawal rules of the National Pension Scheme (NPS), an investor can withdraw 60 percent of the corpus (tax-free) at retirement.
The remaining 40 percent needs to be mandatorily converted into annuity, and the pension is taxable. Popular opinion which discourages investors to park money in NPS usually highlight the pain points about annuity and also the long lock-in period at the accumulation stage.
Yet, NPS, as a retirement product, is suitable for many investors, irrespective of the tax benefits. It has low cost and professionally managed and perhaps the only retirement product that offers the flexibility to invest across equity and debt.
The maximum equity allocation up to a maximum of 75 percent facilitates faster wealth generation to accumulate a decent retirement corpus. It is suitable for investors who are not financially savvy or do not have much experience of equity investing and have peanuts or nil exposure to equity.
The long lock-in period works to the advantage of investors who are inexperienced in handling market volatility. Further, the auto-choice option facilitates regular rebalancing of asset allocation between debt and equity. So, without any biases, investors should holistically take cognizance of all the features of NPS and decide whether it fits their requirement.
Avoid sectoral funds: Another common tenet of investing is to not put all your eggs in one basket. Based on this principle, investors usually refrain from investing in sectoral funds as the risk is high.
Sectoral or thematic funds are very volatile as they invest in a particular sector. While they have the potential to generate higher returns, the downside is also very high, compared to a diversified fund. Still, sectoral funds could be a good bet although they are not for every investor. Experienced equity investors can follow a core and satellite approach to invest in sectoral funds.
The core portfolio is taken care of by taking calculated risks through a well-diversified and goal-based investment portfolio. Then, if investors are left with a surplus and can take higher risks, they can invest in the satellite portfolio, which has the potential to generate alpha for them. Besides the risk-taking ability, investors should also have reasonable understanding of the sector they are taking a call on and the underlying business and its cycles. Sectoral funds fit the bill for such investors.
Index funds have low risk: Passive equity funds have become popular in India in the past few years. Index funds track a particular index. Popular opinion on various online forums and other social media highlights index funds as the ultimate no-brainer solution for any investor.
This has led to the common belief that index funds carry low risk or even no risk at all. Many investors do not even bother to check the underlying benchmark and buy an index fund in the mid- or small-cap category just because the word index is there in the name of the fund.
When it is stated that index funds carry low risk, the context is in comparison to actively managed funds and the former are expected to deliver returns at least in line with the market/benchmark. One cannot, however, ignore the fact that equity index funds are risky because of the fundamental volatile nature of equity as an asset class.
They carry the same level of risk and fluctuate in tandem with the benchmark index.
Then there are common biases about real estate and gold where poor financial decisions are more influenced by the social circle of the investors -- family, friends, relatives, colleagues, etc. The lure of real estate among investors hinges on the popular belief that real-estate property bought in a lifetime never goes into a loss.
In the case of gold, people perceive gold as a must-have in worst times. Hence, people have the tendency to stock up excessive physical gold, and many, surprisingly, also view it as a contingency fund even though it is illiquid.
To conclude, you are bound to make financial mistakes in the 25-30 years of your working life, which is fine. But as an investor, you can try to reduce these mistakes by being rational and objective. This can be done by not adhering to a single opinion too strongly. No financial product is good or bad and should not be written off or bought into, based on your biases. Always think about its suitability. Every financial decision should be holistically based on your financial needs and goals, personal situation and your risk appetite.
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