How does one navigate market risks?

Last week, a reader who has been buying our books right from their very first edition (the current edition is 36th) came to us with a complaint. Here is the gist of the same:

1. You have been saying throughout all your 36 editions that you do not understand why any investor goes to any bank for any investment; when better investment avenues are available with comparable risks. This statement has become more meaningful after most of the banks have reduced their rates on their FDs and worse, also on their Savings Bank Accounts (mostly at 3.5%).

2. One of the other options available were Co-FDs, which you were recommending until came a bolt from the blue. In terms of the new provisions of the Companies Act, 2013, all companies are not allowed to borrow funds in excess of its paid up capital and free reserves. Any excess borrowed had to be returned back to the borrowers by 31.03.2015. Most importantly, as per the Companies (Acceptance of Deposits) Rule 3A, 1975, a certain sum has to be kept aside in the form of Bank FDs for the purpose of repayment of the outstanding Deposits. Strangely, as per the Rules, the company cannot use these FDs to make the payments as required by this diktat. There were many companies which used to borrow funds from retail investors through their FDS, after exhausting their borrowing limits from the banks, by offering higher interest rates. This leveraging enabled them to pocket profits when their income from their activities was higher than interest payable on their FDs. Many companies found that such borrowings were locked in their work-in-progress but since the company was required to stop accepting deposits, it was difficult for them to clear off the excess within one year from 1.4.2014 or from the date on which such payment was due, whichever is earlier. Almost 16 companies, that were earning profits through such leveraging, have been facing liquidation. Therefore this avenue in a no-no for retail investors like me.

3. The other option is direct investment in equities. Well, you have been repeatedly stating that at any given time the current price of any scrip is placed at a certain point at which when someone buys (or sells), only one of them, depending upon his luck, gains and the other loses an equal amount.

As a matter of fact, the entire community of traders taken together will lose by way of brokerage, STT, KKC tax on brokerage, SEBI Turnover Tax, Stamp duty, etc. Therefore, no direct investment for me.

4. That leaves only one avenue --- Mutual Funds. But thanks to the SEBI mandate, I have been repeatedly told that these are subject to market risks and I am supposed to read the offer documents carefully. Well, I do not have time to read over hundreds of offer documents, carefully or otherwise. I respect the wisdom of the SEBI and therefore, I do not want to invest in MFs. Consequently you will realise that I have no option left with me --- no to banks, no CoFDS no direct investment in shares and no MFS. So then what do I do? Like I said, the only safe avenue seems to be banks but their returns have dropped to even below the inflation rate, rendering me earning negative real returns. HELP!

Our reaction: We find that many clients and readers are willing to invest directly in shares – perhaps since there are no ‘warnings’ against such investments. It takes us quite some time to drive home the fact that MFs invest in shares on their behalf. Since such investments made by the MFs are backed by a fair amount of on-line research related with fundamentals, governance standard, future plans, growth prospects, the rise and fall in local and global demand for their products and services, sectoral government policies, etc., the risk is very much lower than direct investment in the shares. Yes, there is a fee charged by the MFs, and monitored by SEBI, for such services. If you have the time, energy and the capacity of taking such decisions yourself, go directly. In any case, there is a risk.

Let us have a good and clear look at this market-related risk. There is an omnipotent risk involved in any action you take and even when you do not take. For instance, when you are crossing a road, a car may hit you. If you are sitting under a fan, it may fall on you. Does this mean that you should never cross a road or sit under a fan? The answer lies in the extent of the risk. Our observation that when you buy a scrip, someone else is selling it and only one of you will be proved right or wrong depending upon how the market moves is a universal truth. This is akin to betting on tossing a coin. Betting on the toss of a coin does not involve any related expenses but market transactions attract some expenses. Agreed, that you become a gambler when your time horizon is just one day – this is akin to daytrading. Day-traders have to settle their buy-sell transactions within a day with sell-buy transactions. Obviously, the risk is less if you have a time horizon of a long period.

The Sensex was launched in April 1979 when its value was 100. On 30.11.2017, 38.5 years later, its value was 33,149, This is a growth of 16.2% (= (33149/100) ^ (1/38.5)). The actual figure is much higher when you add to it the dividends you have received during this period. In other words, longterm investment in the market is not a gamble, it is an investment, creating wealth.

Finally, the most important question --Should one spread his investments amongst debt-based and equity-based schemes of MFs? The idea is good but avoid debt-based if you already have enough investments in such schemes such as EPS, PPF, NSS, banks, etc. Before closing, we have another suggestion. Withdraw as much as possible from your PFs, PPF and bank. Shift to a mix of extreme liquid schemes of MFs which have no exit loads (invest today and exit tomorrow or later) giving a yield of around 8% p.a. and good equity-based schemes. Finally, and most importantly – while you have to take in perspective the statutory requirement of SEBI mandating MFs to declare that investments are subject to market risks, also pay attention to the series where the AMFI relays the message ---