One size doesn’t fit all

Defined contribution (DC) systems

The penetration level of mutual funds among US households is one of the highest globally. What are the reasons for this?

ICI Global just conducted research on this issue. Typically, countries with large domestic fund industries are those with higher per capita income and deeper and more liquid stock markets.

Defined contribution (DC) pension systems that allow for investment in funds are also a key factor in fostering larger fund industries. India has a deep and liquid stock market, which bodes well for its future. And as India’s per-capita income rises, its middle class grows, and as  its population ages, more people will save for retirement and other long-term financial goals. This also should spur domestic fund industry growth.

What has helped US mutual fund industry grow so rapidly, in spite of the recession?

American fund investors tend to have a long-term outlook and this is a great strength of the system. It comes from the fact that investors are using funds to save for retirement and other significant expenses, like buying a house or sending a child to college, that have a long time horizon. For this reason, even during the global financial crisis most savers using 401(k) plans -(the most common DC plans)- kept contributing to their retirement accounts. That decision has rebounded to their benefit.

Much of the growth in assets since 2009 can be attributed to making contributions to retirement accounts, a growing trend towards international equity exposure and the global recovery in equity prices.

The penetration of mutual funds among Indian households is still in single digit despite the fact that a vast majority of Indian equity funds outperform the markets.

Each country has its own circumstances but the United States are strong believers in the tremendous advantages that funds offer for long-term savings.

The system of defined contribution plans empowers individuals by helping them build savings over their working lives. Defined Contribution retirement plans allow workers to own their own assets and control investment decisions. These plans are transparent. They accrue value throughout a participant’s working life.

Indian policy makers may wish to study and consider whether development and expansion of a DC pension system in India might benefit savers and the country’s capital markets.

How are American fund houses carrying out investor awareness programs? How do you measure the effectiveness of investor awareness activities? What needs to be done to make such programs robust?

Investor education and engagement are valuable and important because investors are to be educated and equipped to make sound decisions about their financial needs. US mutual fund companies have a long, proud history of working to inform and teach investors through a variety of creative and research-based approaches. Many of these draw upon the Internet, social media, and other digital communications tools. There’s a lot of innovation afoot. And so it’s no accident that surveys show eight in ten US fund investors feel confident that saving through funds will help them meet their savings goals.

Education and engagement make a difference.

There are  a few fundamentals.

First, investor education cannot fully replace financial advice in supporting investors to make sound decisions. Financial advisors play an important role. Second, investor education should strive to equip potential investors to make choices that best fit their needs and circumstances.

One size doesn’t fit all.

Ultimately, investor education programs that successfully encourage average savers to build more long-term wealth.

They help  themselves and their families through the use of funds by setting up a brighter future .The country in which they live is also benefitted.

investing myths

5 investing myths

Myths concerning investing tend to be costly. They can lead you to take too much risk, or too little. Worse still, may cause you to avoid investing altogether.

Granted, investing is not an easy endeavour.  But by busting certain myths, you can at least venture on the straight path.

Myth I: Saving and Investing are the same

The terms are often used interchangeably, which is an error. Saving and investing are, of course, intertwined and correlated but not necessarily good proxies for each other. They are two different efforts.

Saving is when you do not spend a part of your income but set it aside for future use. Investing is putting that money to work. It involves committing your savings into an investment vehicle with the hope of making a financial gain. So naturally, investing is more of a risk than saving. Having said that, it is worth noting that no one creates wealth by saving. You have to invest the savings wisely to create wealth.

Myth II: Keeping your savings in the bank is a smart move

As mentioned above, saving is one aspect of managing your finances well. Putting that money to good use is mandatory. When looking at any investment, you have to take inflation into account. Your money in a savings account will see its value erode rapidly due to inflation. In fact, it will ensure that you end up with a negative return since the inflation rate is higher than the return on a savings bank account.

Even if you put the money in a fixed deposit, after you take inflation and tax into account, your return will be miniscule.

Myth III: You only earn from your salary

Not if you have invested smartly. There are ways to generate income from sources besides your salary.

Rent: If you have invested in property and have leased it out, you can earn a rental on it.

Dividends: From stocks and mutual funds.

Interest: Bonds issued by companies or financial institutions; fixed deposits from banks, post office schemes and companies.

Capital gains: This is the appreciation you get from your assets when you sell them – stocks, mutual funds, property.

Myth IV: Investing in equity is only for the rich

The stock market is not an exclusive club for the rich. In fact, you can get rich by investing in equity. No one is asking you to short sell or trade. Investing wisely in equity allows you participate in the growth of the company.

Neither do you need huge amounts to invest in equity. With as little as Rs 500/ month, you can invest in an equity diversified fund which will invest in various stocks.

No investor should ignore equity from his/her portfolio.

Myth V: More earnings means more wealth

Not really. You can be earning a tidy sum and letting it all fund your lavish lifestyle. It is not about how much of money you make, but how much you save and invest wisely.

Very few get wealthy by adding up their pay cheques. A high income is certainly helpful but not the sole determinant. Nor are fortunes built through a huge one-time killing in the stock market.

The two fundamental factors that are responsible for individuals’ building wealth are 1) the number of years that an individual has been consistently saving and investing his money; 2) the proportion of his savings allocated to higher return investments such as equity.

This does not mean that stocks should be invested in regardless of the price and risk levels. It is just an indication that if an investor invests wisely, he will get rewarded over the long term

Value of Long Term Thinking

It's an unfortunate reality that on the Indian equity market, a vast majority of individual investors (and even some institutional ones) have an extremely short-term and momentum-driven approach to investments. In fact, we have a deeply set cultural belief that equity investments mean continuous, hyperactive trading.

One of our clients wanted to invest a large amount of money that was lying in his bank account. He was actually apologetic that he didn't have time for trading every day. It sounded like he felt that that trading every day was the default way of making money in the equity market. Therefore, not being able to trade every day should be seen a serious handicap in making money in the market.

This is not a fringe view. Well, statistically it may be a fringe view because a majority of Indians seem to believe that the only ways to make money is fixed deposits, real estate and gold. However, out of people who have anything to do with equity markets, many believe that the way to make real money in the market is to trade every day, all day long.

But why do people who have no familiarity with equity markets arrive upon this conclusion? One possibility is the marketing machine of the investment industry. When someone who has a substantial amount of money suddenly decides to invest it, what happens next depends entirely on chance. How does our potential investor decide to start off? Does he ask a friend, neighbour or colleague? Does he start Googling? If he does, what exactly does he Google? Does he click on the search results or the ads?

Depending on what happens, our newbie investor could end up having a different idea of what to do, and indeed, of what investing is. However, in many ways the situation is primed for disaster. Unless they already know something that makes sense, a fresh customer is most likely to be snared by whichever type of product has the most aggressive sales process. Unfortunately, in personal finance, the most aggressive salespeople are found in the products where they are likely to get the biggest cut of your money.

But here, we believe in a calm and measured approach, of which a long-term approach is an integral part. Equity markets are a roller-coaster ride even at the best of times, and investors need to find stability within the chaos rather than make the chaos worse. This is not a hard thing to do if you follow our approach. Fundamentally guided investments, chosen keeping the principles of value investing in mind, and keeping your own financial goals, aspirations and limitations in mind - that's all it takes.