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When I Have A Demat Account, Why Should I Use A Mutual Fund?

Making investments on your own or hiring fund managers? What makes more sense for you?

Given the recent run-up in the share market, I’ve noticed a few friends and colleagues tempted to do some share trading on their own. I’ve wondered why. Maybe, my friends just don’t know what it takes to invest properly and not lose money?

What it takes to beat a mutual fund manager

Investing well, without losing money, is not just some random activity. There are over 5,000 listed companies in India, and the top 250 companies represent over 80% of the market value. The remaining 4,500+ are all small companies whose business prospects fluctuate a lot. This extreme up and down fluctuation in the share prices of small companies is what generates excitement and greed in an emotional roller-coaster. Daily spam SMS text messages from unknown brokers do not help.

Investing well to make money consistently over time is actually just boring and disciplined hard-work. It involves:

  • Studying industry reports and news in order to do an in-depth analysis of industries, regulations, business strategies and corporate governance issues
  • Focusing on those companies with sound business models, strong growth opportunities, sustainable competitive advantages (called “moats”), and quality management
  • Researching the business fundamentals of the chosen set of companies through interactions with their management, employees, customers, competitors and independent industry professionals. This is almost impossible to do for an individual investor
  • Valuing the intrinsic (or ideal) share price based on the business fundamentals and growth prospects of each company. These valuation methods can change depending on the industry and market situation
  • Constructing a portfolio by sizing how many shares of each company to buy based on how convincing the argument is, while at the same time ensuring the portfolio is adequately balanced, in order to do well at various points in time, as the prospects of the economy and various industries evolve
  • Actually doing the buying to build your ideal portfolio based on varying market prices. This may take weeks, months or even years depending on how expensive certain shares are
  • Building rules to decide when to reduce positions or exit a particular stock, which is arguably even harder than deciding when to buy
  • Sticking to those rules through up and down market cycles. This is the hardest of them all since we are emotional creatures with reptilian brains that are wired to buy (high) during euphorias and sell (low) during panics, which is precisely the opposite of what one should do. Ignoring financial news commentary (noise) is usually the best course of action.

    As you can see, that’s a lot of work and professional mutual fund managers dedicate their life to becoming better at this. Each of us, with a full-time job, will find it difficult, if not impossible, to gain the kind of expertise they bring to work for our investments.

So what should you do

If you have a job from Monday to Friday, stop wasting time dabbling in investing directly. Go through a professional fund manager - usually, he or she works at a mutual fund. You trust trained professionals in other spheres of your life, do that with your money too.

Part-time investing based on random tips, feelings, emotions, guesses or friends’ opinions is at best a serious distraction and at worst pure gambling. Instead, with that time saved:

  • Do a Coursera or Udemy course in Machine Learning, front-end web programming, app development or anything to delight your customers, impress your manager and increase your income. I guarantee you will make and save more this way, than trying to coax your investments to return the money by staring at the trading website.
  • Exercise / do yoga/ run marathons to build the mental resilience and fortitude that is absolutely needed to stay steady through up and down market cycles. Share prices do not go up in a straight line and there will be many periods where your conviction will be tested. You need to stay healthy to stay invested for the long-haul and benefit from compounding.
  • Have fun / spend time with family and friends. You work so hard for just this. Enjoy. Don’t only live for tomorrow. Conversely, tomorrow does come, so prepare for it, but in the right measure.

Ultimately you need to clearly understand what you’re good at, and what you’re not (your “circle of competence”). Focus on what you’re good at and outsource the rest to trained professionals - be it a doctor, a lawyer, a gym instructor or mutual fund manager. Focus your time on making more and saving more, both of which are under your control. Just because you can, doesn’t mean you should.

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