The Signal : Building A Firecracker Portfolio That Won’t Fizzle With Time

We all know that Diwali is the festival that celebrates the anniversary of Lord Rama’s homecoming after an exile of fourteen years, but have you ever wondered why was it fourteen and not perhaps ten or twenty? Also, is it purely coincidental that a criminal’s minimum term to serve in prison if awarded life imprisonment is also fourteen years?

Also, did you know that if your investment continues to grow at just 12% p.a. and compounds for fourteen years, the value goes up to 5x!

Well, I know you were expecting a response to why the exile period and minimum life sentence period are both fourteen years; but honestly, I couldn’t find a credible reason or logic behind the period wouldn’t be entirely surprised if it were merely a random choice.

However, I’m pretty sure of the investment mathematics that followed.

See, many things in life may or may not function based on a solid logical framework and hence continue to remain open-ended questions like the ones above. But, investments, on the other hand, function bases a solid logic wireframe (logic is a diverse term – it includes emotional logic, social logic, mathematical logic, etc.) and embed a predictable cause-effect relationship.

But then, why are stock markets so erratic if everything investment is perfectly logical?

Aha! Here’s where one must realize that market forces (read demand-supply) are driven by logical and anti-logical drivers (includes speculators).

But, here’s the good news – the forces erratically sway stock prices only in the short-term while logic and cause-effect win in the longer term!

Borrowing an analogy from Jeremy Grantham:

“Think of yourself standing on the corner of a high building in a hurricane with a bag of feathers. Throw the feathers in the air. You don’t know much about those feathers. You don’t know how high they will go. You don’t know how far they will go. Above all, you don’t know how long they will stay up…

… Yet you know one thing with absolute certainty: eventually, on some unknown flight path, at an unspecified time, at an undisclosed location, the feathers will hit the ground, guaranteed.

There are situations where you know the outcome of a long-term interval, though you absolutely cannot understand the short-term periods in between. That is almost perfectly analogous to the stock market.”

Case in point – 

Kingfisher Airlines (never hit profitability) no longer stands with a ~INR 4,500 Cr. market capitalization (total value of all KFA shares in 2007-08) and Reliance Industries Limited (a valuable conglomerate with vital profit metrics) achieved the highest ever market capitalization for an Indian company – INR 9 Lakh Crore.

Okay, the feather will land. But when? 

Point one – nobody knows ‘when’ will the feather land, but one can arrive at a probability basis a strong understanding of the direction and velocity of the hurricane – all one needs to do is, let it fly and touch it only when it seems to be going in an undesirable direction.

Simply put, it is imperative to invest with a long-term view and understanding that it may witness intermittent volatility and the only reason to meddle with it is when something fundamental goes wrong or there has been a meaningful change in your risk or investment profile.

And how do I know if my investments are going the Kingfisher way or Reliance Industries way in the long term?

Two words – nobody knows.

Hence, diversify – diversify efficiently through mutual funds wherein the fund manager is among the most qualified to manage investments. He deploys your assets in a risk-optimal fashion across several securities that suit your investment profile and lend reasonable sustainability to your portfolio.

At the same time, active management ensures reasonable checks at all points in time to ensure that any holdings that are going straight for a crash landing is exited and your investments are allocated towards the ones that are going to take off well or are already cruising at great heights and will continue to do so.

While the world makes new year resolutions, there’s complete merit in making a Diwali resolution to stick to disciplined investing, seek reliable guidance on investment portfolios & not meddle with it unnecessarily because of intermittent speed-breakers.

If you are determined to stick to disciplined investing but seek guidance on the ideal portfolio for you, feel free to reply to this e-mail & let our domain experts guide you through your financial adventure.