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Kirti, a selector, wants to make money by backing a batsman based on his long-term performance. After scrutinising the statistics of several batsmen over a hundred matches, he decides on one. However, he gets upset when his chosen player doesn’t perform well in the next match, and in fact the entire series. He overlooks the fact that the other batsmen have fared equally poorly.
Despite the chosen batsman still having the best average performance over a hundred matches, Kirti’s disappointment doesn’t abate. He unrealistically expects the batsman he has backed to perform well every time, forgetting his initial strategy of backing a batsman based on his long-term performance.
Cut to investments. I narrated this imaginary story to our client Radha. She was going through the status report on her investments started six months ago. She expressed unhappiness at their rather low returns and enquired whether they needed to be replaced. I told her the performance statistics of her investments over six months were akin to data shown on the television screen while a match is going on — useful to know which way the match is going, but not useful for selecting a batsman.
Similarly, an investment’s performance over six months is not a good basis for deciding to review the investments. “Should we never review the performance of an investment then?” Radha asked.
“Of course, we should. But it needs to be based on its long-term performance data compared to peers. We had shown you data for the past 20 quarters for all the investments based on which this one was chosen. We have updated that data to reflect the quarters 21 and 22. The cumulative data from quarter 3 to quarter 22 continues to show the investment as among the top performers,” I answered.
It was tough for Radha to understand why the investment status report was not a correct basis for reviewing her investments. But she had to agree in the face of the inexorable logic presented to her.
Radha said she now understood the difference between an investment status report and an investment review report. But what was the plan review document we were giving so much importance to? Again, using cricketing analogy, I explained: selecting a batsman based on his long-term performance (akin to investment review) is different from deciding the composition of the team — how many batsmen, all-rounders, bowlers, and the wicket-keeper.
In a proper plan, it is important to decide on the proportion of investments in equity, fixed income, international equity, gold, and real estate based on goals, availability of resources and the investor’s risk-taking ability.
Choosing the specific instruments or schemes within each of these investment types based on a set of long-term criteria comes next. A good plan will also consider the physical and emotional health needs of the individual (just as in cricket one looks at the physical and mental well-being of the players). The plan review looks at all these parameters to take a call on whether any one of them needs an adjustment. Thus, in descending order of importance and impact on the success of any plan would stand the initial plan and review, initial investment selection and review, and ongoing investment status reports.
My favourite maths teacher in school had once remarked, with a mischievous smile, “I want each one of you to score above average marks.” This, of course, is a mathematical impossibility. Truth be told, it’s important for investors to have realistic expectations from their investments, or else they are setting themselves up for disappointment.
The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor Twitter: @harshroongta
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
(A slightly different version of this column first appeared in the Business Standard on May 22, 2023)