Prediction Pitfalls

Last week, I analysed equity mutual funds’ performances over the last three years.

As I had said, the last three years were an unusually interesting period over which to evaluate funds. it had seen a tremendous stock price boom, a crash which became deeper and deeper and then, an unexpectedly quick resurgence. No matter how interesting the past is for a fund analyst, there is no point in analysing it, unless it holds some lessons for the future. However, I won’t use the word prediction because, if the last two years have demonstrated anything, it is the utter uselessness of trying to forecast what will happen over the coming year.

Back in December, 2007, the equity markets were looking inflated and the general idea was that it would be a dull year in 2008. What turned out was an utter disaster. Make no mistake, the global nature of the financial crisis unfolded much later in the year. As early as January, 2008, the markets gone through a huge crash for reasons that were purely internal to the levels that stock valuations had reached. 2009 again defied predictions. The investment markets were buried deep in pessimism by the end of 2008. While the first four months did live up to that billing, the period after that again defied expectations in the suddenness and the speed of the recovery of stock prices.

While short-term debt continued in its steady way, longer-term debt fund investors have had even more of a roller coaster ride. Towards the end of 2008, as the Reserve Bank of India (RBI) unleashed a flood of low-priced rupees to stimulate the economy, longer-period debt multiplied in value and many medium-term debt funds gained 20 per cent or more in a couple of months, or less. The period after that has been a lot less cheerful with most medium term debt-fund categories gaining a marginal 1-to-2 per cent in the entire year. The more rate-sensitive long- and medium-term government securities funds have had a much more torrid time — the average fund is down 4.5 per cent with about a fourth of the funds losing close to, or more, than ten per cent for the year.

At the end of this year, it is clear that I will be doing my readers a huge disservice by making any predictions at all. Instead of predictions, the right thing to do is to lay down principles — investing principles that would stand the test of time and serve you well regardless of actual events.

One year ago, I’d advocated this strategy: Take a look at your own life and try and make a liberal estimate of how much of your savings you would need to tap into over the next five-to-seven years. This would include some sort of an emergency amount, plus predictable big-ticket expenses like weddings, education, the down payment on a house and other such things. This is the amount you should hold in debt investments which could be anything from PPF to short-term debt mutual funds. The rest should be in diversified equity mutual funds with a good long-term track record. Any fresh investments into equity funds should be done gradually and continuously regardless of the state of the markets. Don’t invest in too many funds — four, or five, is enough for the sake of diversification.

A lot has changed during this year. However, there’s no need to change even one word of this strategy. And that’s the way it should be.



By Dhirendra Kumar
Dec 28, 2009