To invest, understand: How to become a successful investor They may feel intimidated by their lack of advanced mathematical skills or swayed by the impressive rhetoric of financial professionals
Dhirendra Kumar
CEO, Value Research
Warren Buffett, the legendary investor, once said that if calculus or algebra were required to be a great investor, he’d have to go back to delivering newspapers. To be a successful investor, one doesn’t need any more math than simple addition, subtraction, multiplication and division. Don’t tell this to the professional peddlers of complexity who seem to infest the world of investing.
Some years ago, a young bank ‘relationship manager’ asked me for an asset allocation formula. He planned to input his clients’ data into an equation that would magically determine the optimal distribution of funds across various asset classes. I had to break the news to him that there was no such formula. I explained that ideal asset allocation relies more on rules of thumb, which are then tailored to an individual’s unique life circumstances. The process involves considering numerous qualitative and non-quantifiable factors that cannot be reduced to maths.
He was visibly disappointed by my response. He had hoped for an impressive formula with a sufficient number of Greek letters. The more calculus it involved, the better it would be as it would undoubtedly impress his clients. He made it clear that he felt let down because either I was unaware of such a formula or was unwilling to share it with him. The idea that there was no set formula was unacceptable to him.
While this man was in the profession of selling fake complexity, many investors too are unable to accept that investment can be simple. The difference is between trying to look at the questions and answers, and trying to understand the logic behind the answers. Take asset allocation. You can accept it as a given instruction, or you can understand why you should do it. The concept of asset allocation is rooted in the idea of diversification, of not putting all your eggs in one basket. By spreading your investments across different asset classes like equity, fixed income and others, you’re essentially hedging your bets. When one type of investment takes a hit, the others might hold steady or even flourish, helping to balance out the overall portfolio.
Once you know the logic, you can take the next step yourself. You already know that equity earns more, but has greater ups and downs, while it’s the opposite with fixed income. Combined with the knowledge about why we should have asset allocation, what does this tell you about your actual asset allocation for different life stages. However, my topic is not asset allocation. It’s about the importance of understanding the underlying logic behind investment strategies and concepts. When you grasp the fundamental principles, you gain the confidence to make informed decisions and adapt your approach as needed. No one can force you into believing imaginary formulae.
Too often, investors get caught up in the allure of complex formulae and fancy jargon, thinking that these hold the key to investment success. They may feel intimidated by their lack of advanced mathematical skills or swayed by the impressive rhetoric of financial professionals. However, even legendary investors like Buffett emphasise the importance of simplicity and common sense over complex calculations. By understanding the building blocks of investing, such as the relationship between risk and return, power of diversification, and impact of time horizon, investors can develop a solid foundation for making sound decisions. They can see through the fog of complexity and hone in on the factors that truly matter for longterm success. This understanding breeds confidence. When you know the why behind the what, you’re less likely to be swayed by short-term market noise or investment fads. You can stick to your strategy with conviction even in the face of market turbulence or conflicting advice.
(The author is CEO, VALUE RESEARCH)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: India Times - Author:Faqs of Insurances
