How to take the best money decisions

Whenever I am confused and have no definite answers, I am torn between acting with knowledge and information.

Confusion arises from the fact that people tend to act on information without applying knowledge.

I am not talking about complex things like PE, forward PE, BV, EV, etc. I am talking about simple, basic things that affect investments and, thereby, the overall value of your assets. These are very obvious, yet very little understood.

Let me highlight four examples that, I believe, are quite pertinent now.

1. Interest rates

Let’s talk about short-term interest rates. The equation is simple: if rates go up, markets go down and vice versa. That is all that there is.

Basically, the government hikes interest rates to regulate the economy. Let's look at the simpler side: people are generally risk or loss averse and tend to prefer security in their earnings. So if interest rates rise, the money moves to safer, more secure havens.

Money tends to move where it is treated best. Unfortunately, for us, institutional money moves at a pace that retail investors cannot match. Hence, before retail investors act, they would have accumulated reds in their portfolio.

What should we do to act knowledgeably? If rates are rising and stock prices are falling, the reverse will also happen in due course. Rising interest rates does not mean you start selling. Perhaps you could start selective buying.

Rising rates can have severe effects. And it is wise not to be too aggressive in such times.

2. Index levels

The second thing most people do is make decisions based on the index levels. This does not make any sense. Why? Very simple. The indices -- Sensex, Nifty -- are generally a very poor measure of the overall health of the market. They represent a few stocks and are subject to movement in a few stocks.

If you really want to study the trend, perhaps you should look at the advance/ decline ratios for a while, perhaps months, and then make an analysis. That will give you a broad level insight into the real health of the market.

Companies are an ongoing concern. A falling index does not mean the company will shut down and the business will not grow. A well managed company will continue to make strategies to tide over differing demands based on their product/ service life cycle.

3. Price

A Rs 30 stock is not necessarily cheaper than a Rs 300 stock. The real value of a stock does not depend on market price. It depends on the earning capability of the company.

In the short term, it is driven by emotions. But, in the long run, earnings dictate the gains you make as a shareholder. Similarly, a Rs 10 net asset value (NAV) does not mean a new fund offering is cheaper than existing ones.

So even if you invested in a Rs 200 NAV fund in both cases, your fresh money will enter the market at almost the same time. In all probability, if the fund NAV is Rs 200 or so, look at its inception date. This will reflect the manner and consistency with which the fund has been managed over the years. That would be a knowledgeable, prudent decision to make.

4. Dividends

Dividends from shares and mutual funds are quite different. The first is reflective of a profitable company that is keen to add to shareholder wealth. This is healthy, welcome and the more, the better.

Now, investing in a mutual fund based on information of the dividend declaration is ridiculous. It is your own money coming back to you. The market value of your investment is the difference between what you invested and the dividend you got.

You would have done a couple of transactions instead of one with no particular benefit. To have this money treated as tax-free income, you need to hold your investment for many months.

What if, in this time, the fund under performs or does not perform in line with peers? You would have made an opportunity loss.

In the times we live, information inflow is ample; knowledge is really sparse. It is, unfortunately, only available by doing all the hard work yourself.

The author, Kartik Jhaveri, an expert at Financial Planning, is a Certified Financial Planner and a Chartered Wealth Manager. He may be reached at kartik.jhaveri@transcend-india.com.

Disclaimer:

The contents of the above articles are the intellectual property and copyright of the author, Kartik Jhaveri. No part may be used or reproduced in any form or manner. If you choose to act upon the information contained in the above article it is at your own risk. This article is purely educative and you are strongly advised to consult an expert prior to taking any significant decision.