Depending on how they define the problem of wealth creation, investors approach the market through three principal viewpoints.
1. Focus on market news and be nimble with your portfolio to create wealth.
Viewpoint 1 will keep you involved in markets and busy at all times. While you are at it, you will feel good for doing so much activity, especially when times are good (in bull markets). But you will be out of action (probably nursing irretrievable losses) in bear markets. Also, taxes and transaction costs will ensure suboptimal results. The assumption behind such an approach is your ability to outwit other intelligent investors in the market. Such an assumption is highly contentious.
2. Do a Systematic Investment Plan, whether it hails or snow.
Viewpoint 2 will ensure you participate in markets. It’s a good way for dumb money (no offence meant) to participate in markets and attempt to get at least the average result (which is difficult for most). For investors, it is vital to know that returns on monies invested will depend on the price at which you invest. Hence, investing at high prices will generate lower returns, while investing at lower prices will generate higher returns. Hopefully, the two will cancel out over a few decades to generate the average result with minimal effort. As professional investors, we recommend avoiding timing markets like viewpoint 1. However, investors should price the markets by not investing when valuations seem egregious. While in opposition to the generic asset manager’s goals of accumulating more assets in all market conditions, such an approach is logical for someone aiming for reasonable returns with basic knowledge of price-to-earnings and dividend yield of market indices like the NSE 50 of BSE Sensex.
3. Invest in the long term and forget about markets, but be benchmark aware
The highest wealth creation does not come from the 1 and 2 viewpoints but viewpoint 3 due to the absence of taxation and transaction costs. In addition, only viewpoint 3 allows for wonders of uninterrupted compounding, possibly a jump in the wealth bracket.
To follow viewpoint 3, you need to solve two aspects.
Asset allocation: in our experience, on average, asset allocation explains 70% to 100% of portfolio returns. You need to appreciate relative (prospective) yields of various asset classes and not just buy the latest performances. You will need to be decisive and contrarian to get this right.
Security selection (in our experience, on average) explains approximately 15% to 30% of average portfolio returns. You should invest in securities only after having a relatively good understanding of underlying return drivers and individual securities’ risk. The understanding you arrive at has to be superior in mapping reality compared to most other investors to generate excess returns above the average outcome.
Please excuse us if you prefer viewpoints 1 & 2 or the thinking behind them. We wish you good luck with your efforts.
Zara only attempts to solve the problem of creating wealth through viewpoint 3. You can start a conversation with us if you agree with our perspective. Let us warn you that the path entails adopting a process that requires immense patience (long holding periods) and willingness to educate yourself to follow such a low activity (consequently low cost), risk-mitigated, and high aggression path (acting decisively when the opportunity provides for it).
“The trick, it seems to us, if one is to be a successful long-term investor, is to recognize the sources of enduring business success, get in early and own enough to make a difference.” —Nick Sleep