Logic vs. Emotion
Nikita started her investment journey with a portfolio of ₹10 Lakh and used the textbook allocation framework of 60% equity and 40% debt. In 3 years, her portfolio grew to ₹16.5 lakh, but now her allocation is 75% equity and 25% debt.
She now has to sell ₹2,47,500 worth of her star, high-growth equities. The textbook answer is clear and logical. But she can't seem to do it.
Emotional instances like this happen all the time to investors, and overcoming them is what differentiates a systematic investor who keeps growing from an emotional investor who keeps losing money due to bad choices.
Let's walk through a few emotional traps and how to overcome them.
The Greed Trap: Fear of Selling Winners
The small-cap and index funds delivered fantastic returns over the past few years, and now they feel like prized possessions to be retained at all costs. The investor mistakenly believes the bull market will last a little longer and that those funds will continue to generate high returns. This is a well-documented behavior called the "Endowment Effect", where people assign more value to something simply because they own it.
The Mental Reframing:
By channeling the extra equity funds into slow-growing debt funds, the investor is protecting the profits made over the last few years. Market crashes can happen unexpectedly, and subsequent actions may be too late to save those profits.
The Cure: Rule-Based Framework with Time-Based Trigger
Expert investors and fund managers protect their profits by relying on the Rules-Based Framework with a Time Trigger. It uses a calendar date to determine rebalancing decisions for the investor's portfolio.
The investor can choose any date once or twice a year to check the asset allocation. If it is skewed away from the target, then rebalance it. The investor strictly avoids checking their investment app, no matter what happens in the market. This removes the emotional decision of tracking your portfolio, along with the anxiety, and gives control to a calendar.
The Micro-Management Trap: Aversion to All Losses
Easy access to investment dashboards has enabled investors to constantly monitor their portfolio fluctuations, adding to their anxiety about future losses and leading to overthinking to come up with quick loss-aversion strategies.
The Mental Reframing:
Investors need to ask themselves, "<i>Can I really devote so much time and energy in a single day or week to monitor my funds?</i>" For most investors, the honest answer is no.
In that case, one needs to find out how often to check their investment app and when to take action.
The Cure: Rule-Based Framework with Threshold-Based Trigger
Systematic investors use the Tolerance Band Rule. This rule defines a percentage threshold for the tolerated change in the allocation of funds. This is the "Do Nothing Zone". This removes the anxiety caused by constant check-ins on the investment app and the indecision that such investors likely face.
Suppose the target allocation is 60% Equity and 40% Debt, and the tolerance is decided to be 5%. The investor will strictly take no action, as long as the allocation is between 65% and 55% Equity.
The FOMO Trap: Managing too many Schemes
Many investors who have been in the market for more than 5 years end up with an unmanageable number of fund schemes for various reasons.
They are either chasing New Fund Offers (NFOs) or the "Star Fund with 40% returns" that they hear about in the news every year. It is really easy to start a new fund with one click, but psychologically it is much harder to stop an existing fund. So funds keep piling in the portfolio. Indian FinTubers promoting "Top 5 funds" have also somewhat added to this situation.
Many investors also wrongly believe investing in 10 different fund schemes is diversification that will reduce their portfolio risk, when in fact it will only add to the headache of managing so many funds.
The Mental Reframing:
When a new, shiny fund is advertised, check for any overlap between its holdings and your existing funds. If yes, that means you are already reaping a good part of the benefits of that high-performing fund.
Many investors follow a hard ceiling on the number of funds they will have. That is because there are yearly expenses for maintaining a fund. It is wise to ask, "<i>Do I want to keep paying the expense ratio for 10 or 18 fund schemes?</i>" The answer will always be no.
If sectoral and thematic funds are booming in the equity market, such as in manufacturing, defense, or energy, and new funds are being advertised, their fund manager has probably already allocated their assets to shares of that booming sector. No worry or action is needed here.
The Cure: The 4-bucket Portfolio Consolidation
To quickly check for fund overlap, use any of the free online calculators, like the Advisorkhoj Mutual Fund Portfolio Overlap Calculator. Many investors treat overlap above 50% as a signal to consolidate. Otherwise, you may need to replace the old fund with the new one.
One common approach investors use is to keep a maximum of 4 Core Equity Funds: 1 Large or Index as a core foundation, 1 Flexi-Cap for flexibility in growth, 1 Mid-Cap as a growth engine, and 1 Small-Cap as the aggressive growth engine. When evaluating which existing funds to let go, pick the one with the most consistent long-term track record and consolidate the others into it.
When choosing new funds, investors often ask if they are willing to let go of an old one. If the answer is no, then they don't actually believe in the new fund. Instead, if the new fund does look superior, with better rolling returns, a lower expense ratio, and great management, then they should absolutely be bought.
To check for sectoral changes in the portfolio, go to the "Fund Factsheet" and then to the "Sector Allocation" or "Portfolio Disclosure" tab. Scroll down to "Sector Allocation" or "Top Holdings."
Conclusion
Nikita diligently follows all the above rules and successfully protects her ₹16.5 Lakh portfolio from the next market crash. Many investors like her find that successful long-term investing is not about frantic late-night trades across 18 different funds, but rather about following simple, disciplined systems that are extremely boring but also highly rewarding.
Happy investing!
<i>Disclaimer: The information provided in this article is for educational purposes only and does not constitute investment advice or a recommendation to buy or sell any mutual fund. Mutual fund investments are subject to market risks. Please read all scheme-related documents carefully before investing.</i>
Responses
Join the conversation
Sign in to share your thoughts and interact with the author.
Sign In to Comment