If you were told that just by reading this article you will know how to be rich instantly, you will give this your undivided attention. However, if you were told by the end of this article you will be wiser about investing, you will immediately scroll down or close the tab. While you are ready to find out all the ways of getting rich, if someone offers you wisdom you scoff. Why is it that you accept the first offer and reject the second one? If you think deeply, you will know that knowledge accumulated overtime and applied correctly will make you rich. However, most investors including you and me are always lured by instant gratification. If we want something and someone promises we can get it tomorrow, why wait for another 20 years. In that rush, we forget the risks and most do not smell the trap. We are slowly internalizing the concept of instant gratification. Our sense of a good investment and bad investment are also deep rooted in Immediate Achievement.
The Theory of Immediate Achievement
When do you call yourself a successful investor? The measure of a successful investor is the returns they generated from a particular fund or stock and how quickly they have generated it. Unless you have had stellar returns or profits nobody considers you a successful investor, including you. This is simply because our skewed understanding where investments are correlated with returns. This is immediate achievement theory in play, where the success is measured by the immediate short term result than the long term impact. This theory was pioneered by Clay Christensen, a professor of Harvard Business School. The idea is elaborated in his book and Ted Talk named “How will You Measure Life?”. It talks about the choices we often make through our finite minds. We necessarily look for tangible sense of achievement which is often reflected through our salary cheques, promotions. Even when making personal life choices we make decisions that will give us immediate gratification and remove anxiety. Hardly do we ever give importance to long term decisions because it is too far away to be gauged by our finite minds. The theory when applied to modern day investments can shed light upon investment behaviour and why people invest the way they do.
This advertisement right above knows that we are looking to get rich immediately. The instant gratification is preyed upon by different sources and investors land on losing much more and gains still remain far away in the horizon. The easy solution that it claims to offer will have the wisest among us saving that last thirty bucks and participating in the race to be crorepatis. Most importantly this solution provides a sense of immediate measurable achievement.
Shortcuts: An Investor’s Saviour?
Have you ever been in the situation where there is too much traffic on the main road and you take a “shortcut” to get to your destination faster? However, you find yourself stuck in the shortcut way longer than the main road traffic. You have nothing to do but wait and regret this bad decision. It turns out that the habit of taking shortcuts extends to our investing life as well. While you take these shortcuts have you ever wondered, how these short cuts gets created? These were created by experts who have been in varying situations to be able to formulate a rule of thumb or shortcut. We love to use rule of thumb and ignore the exceptions that usually accompany them. More often than not, these exceptions determine the ultimate result than actual rule of thumb.
The Asset Allocation Shortcut
A common rule of thumb while determining the asset allocation of investors is (100-Your age) gives you the percentage of equity investments. If you are 30 years old you should have minimum 70% in equity investments. It is a common method used to determine equity investments. Investors have internalized it. However, this does not take into consideration the needs of the personal and investment needs. Neither does it help you allocate the type of Equity.
An investor invests 70% of his investment in Large Cap Funds going by the rule of thumb. You did not consider the other Equity options available. The fact that a proportion of investments in Balanced Fund or Diversified Equity Funds could have given better results was not within your investment awareness. As a result, you did everything seeming right but you may not have some of your goals.
The Returns Shortcut
This a question asked by a user on Rediff user. Now let us be honest. We all have been looking answers to this question even though we may not have posted it on Rediff. If only there was a shortcut rags to riches story would not be the tales of inspiration. However, we all apply one shortcut in our pursuit to get richer. We determine a Mutual Fund’s worth based on returns and solely on returns. It is common nature to scroll down and focus on the returns and ignore all the other background information.
In the example above, using the investment shortcut, you will greedily go for Fund 1 because it promises better returns. That is enough to make your investment decision. However, the expense ratio i.e. the percentage of returns that is used to incur management and advisory fee is nearly 3% which is on the higher side. So the actual return is approximately 16%. The fund that you are likely to ignore is the one that generates a return of 17%. However, the expenses ratio is less than 1.00 or 0.56% only. The actual return is 16%. Do you see that the returns from both funds are nearly the same? What makes the difference? The expense ratio and its gradual effect on actual returns. In the long term Fund 2 might become a better fund because it is managed at a lower cost generating higher returns.
Shortcuts and Immediate Achievements
As investors we focus on immediate achievements. The instant gratification illusion is created and maintained by our short term achievement. These blind us to the long term impacts that it can have. A fund that has generated 95% returns in the short term and you have invested in it generating heavy returns. You stay invested ignoring the fact that stellar high returns are a mark of volatility. Then the fund comes crashing down eroding your returns and maybe part of the capital as well. You went for immediate gratification and ignored the long term impacts. Usage of shortcuts and gratification from immediate achievement is closely related.
When I started writing this, I did not make any promises on delivering shortcuts to being rich nor did I promise wisdom. It is simply because the takeaway from a write up is not determined by the writer but the reader, in this case the investor. Do you realize what has to change? The definition of a successful investor! It is not the one who makes quick profits rather the one who stays invested for a long term, a solid portfolio, and fulfilment of every financial goal in the long term. The key to success lies in the long term. You went through 16 years of school and three to five years of college education to land yourself a secure living. This is an investment in you. You get the returns in terms of your salary, your living standards and so on. So if someone invests odd twenty years of life to build a career, why are we not willing to wait the same period of time to build ourselves a high return oriented portfolio? You know and so do I, there are no shortcuts in life and no getting rich fast. Can you get rich? Of course you can. Can you get rich tomorrow? You already know the answer to that.