Is there an easy answer to this complex question? I do not think so. However for a big part of the crowd Indexing will work. Do I do Indexing? No? Is there a conflict in what I do and what I say? Well, read on.
First of all the advantage of being financially independent is that one need not worry on a day to day basis about the money you have, the money you make, alpha, beta, …the Greeks, etc. Honestly as long as my income is greater than my expenses I do not worry about whether I generate alpha on a regular basis, or even, at all. Honest to God, it does not matter.
Having said that, my portfolio hardly mimics the index – I have a big exposure to Coromandel International – which has no corresponding friend in the index.
Let us see why Indexing works:
a. Low cost: compared to a ULIP or even a regular mutual fund an index ETF is really cheap. It is really hard for a fund charging 2.5% amc to beat a fund that charges 0.05% amc. It is really tough. Try the math.
b. taxes, fees, transaction costs can only reduce the returns, but of course the dividends enhance the returns. However when it comes to comparing to the TRI, there is no way how a real life index fund can beat the index! Forget a managed fund beating the index. It is tough indeed.
c. A few funds will beat the index when there is some kind of a lopsided rally – say when 5 companies do abnormally differently from the index. We saw it recently in the Indian context did we not?
d. the alpha chase by the fund manager actually happens by the fund manager increasing risk. What can you do? grin and bear it. Personally I have substantially exited shares, sitting on cash, deleveraged, have no debt, and not willing to commit the cash on which I am sitting. No, I am not in a hurry to even buy beaten down mid-cap.
e. Stock selection is tough: I don’t think that more than 100 companies have created wealth for the shareholders – consistently and over long periods of time. Now try creating wealth by choosing from 9000 companies because many of these 100 shares are highly valued. Man, it is tough. In the current market it takes a brave man to buy Nestle, Gillette and PnG. All wealth creators of the past.
f. Good investing is a lot like staying healthy. It’s really easy in theory and really difficult in reality. Worse, it is simple does not mean it gets done. We all know how to get healthy (eat right, work on your flexibility, strength, and core). We also all know how to invest well (diversify, reduce friction like taxes/fees). However, we are constantly bombarded by emotional temptations all along the way that negatively impact our health and our diets. Like Morgan Housel says we have to work on ourselves a small bit every day. Even that is tough, but we all know that yoyo diets fail. The best plans are the ones that you can stick with so that you maximize the return while controlling your emotions. Buying an index etf is so damn boring that you will dare not talk about it in a social gathering – damn ‘Subra how can you be so DUMB that YOU need indexing” – is a shit scary line is it not? Indexing works because it’s simple enough to instill the discipline in you to stick with the plan and just getting getting healthy that discipline factor is the difference between success and failure. Simple MAY not necessarily better, but simple is going to be easier for someone to maintain over time. I am at an age when I have to keep asking myself “am I senile or should I be still managing my portfolio”. As of now I like the echo!!
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