Portfolio Ideas: How to reduce investment regret

You may have invested in an equity fund only to see the market tank thereafter. Or you may have watched an equity fund generate 15 per cent return a year after you sold your units for substantially lower gains.

Such incidents happen in all our investing lives. Regret over the past can adversely affect our subsequent investment decisions.

In this article, we discuss how to reduce such adverse effects by avoiding certain active investment decisions.

Active decisions refer to the manual actions you take to complete your investment decision. This could be a complex action such as investing in a different mutual fund each month, or a simple action such as investing in the same fund on a particular day every month.

Both the actions can cause regret. How? In the first case, the mutual fund you choose can subsequently perform poorly against peer funds. In the second case, you may buy units a day before the market declines. You, thereby, lose the opportunity to invest cheaply the next day.

Because you take an active decision each time you invest, you will suffer regret even if you invest in the same fund on the same day every month!

To avoid such regret, you should engage in “Active Distancing”. That is, you should actively distance yourselves from your investment decisions.

Such distancing reduces regret and is, therefore, important for managing your core portfolio. This is a portfolio that you create to meet your life goals.

How should you engage in Active Distancing? You should set up an automatic process to accumulate wealth to meet your life goals. The easiest way to do so is to set up a systematic investment plan (SIP) in an equity mutual fund.

Why does Active Distancing help? After 2-3 months, your brain distances itself from the investment process. That is, your brain will not consider each automatic debit as an active decision. This reduces your anxiety levels, even if the market is volatile.

You can further reduce your regret by choosing index funds over active funds. Why? The higher the dispersion in returns among peer funds, the higher the regret; for the chances are higher that the fund you buy subsequently performs poorly against its peer group. Now, all index funds generate similar returns as the benchmark index, while the dispersion in returns among active funds is higher.

Active Distancing on bond investments has a different effect. As a retail investor, your bond exposure will primarily be in recurring deposits with banks. In this case, the bank automatically debits your savings account every month.

Remember, anxiety arises typically from uncertainty. But there is no uncertainty about the income returns on bank deposits. Therefore, as the brain distances itself from the automatic debits, Active Distancing will lead to a pleasant experience — when a lumpsum amount is credited into your bank account at maturity.

You have to take active decisions on your satellite portfolio, as it is set up to take advantage of short-term fluctuations in the stock market.

To avoid regret, you can enter into an Active-Distancing switch with your friend. This is a situation where you and your friend take active decisions for each other’s satellite portfolio!

Why will this help? You will be simply executing the instructions given by your friend to manage his or her satellite portfolio. Your brain will not consider such actions as active decisions; you “are” the auto-debit for your friend and vice versa! Therefore, you will not suffer regret for taking actions to manage your friend’s satellite portfolio!

If engaging your friend is not possible, your spouse can execute the actions for your satellite portfolio. Alternatively, consider outsourcing your satellite portfolio to an investment advisor. You may forgo the excitement of timing the market; that is the cost you have to pay if you want to avoid regret.

The author is the founder of Navera Consulting. Feedback may be sent to portfolioideas@thehindu.co.in