Will you earn better returns by not being too active?

May 13, 2014

In this issue:
» Will the Chinese Yuan replace the US dollar?
» Inflation in the US will eventually rise
» A Modi victory could spell trouble for governor Rajan
» Jim Rogers gives his views on stocks and gold
» ...and more!

When you own a portfolio of stocks, do you feel the urgency to keep buying and selling stocks and feel restless when you don't? If the answer to this question is yes, then chances are that the returns on your portfolio will not amount to much in a longer time frame.

One of the reasons why it is beneficial to invest in equities is because the compounded returns generated from them are higher than what fixed income or debt can deliver. However, there is an important catch that one should be aware of.

As per an article in Moneynews, Jack Bogle, founder of the Vanguard Group, has stated that while compounding does great things for investors' returns, it does terrible things for their costs. To further illustrate his point, Bogle used a 65 year time horizon and concluded that if one invested US$ 1,000 for that period, the returns that would be generated at the end would amount to US$ 148,780. That is assuming the historical stock market return of around 8%. But is US$ 148,780 what an investor actually ends up getting? Not really. What he ends up with is a return of around 5.5% because around 2.5% is eaten up by costs.

What are these costs? These are the fees charged by money managers, stockbrokers and the like who are entrusted with the management of investor funds. According to Bogle these intermediaries put up zero percent of their capital, take no risks but end up pocketing around 80% of the return.

Does that mean that one should practice more of passive investing? Bogle certainly seems to think so and we cannot help but agree that he makes a very valid point.

While Bogle based his findings based on the US stock market, it has utmost relevance for Indian investors too. Take mutual funds in India for instance. There is this pressure on fund managers to churn portfolios, but does that impact returns? It does because more churning means more expenses that eat into returns generated by the fund. Apart from this, churning may generate poor returns if a mutual fund ends up exiting good stocks too early without utilising investment opportunities to the fullest.

Of course, it doesn't mean fund houses which do not churn would surely generate good returns. This is because it depends on the quality of the stocks that the fund has invested in. Having said this, it has been observed that funds which have generated superior returns consistently have rarely indulged in excessive churning.

Hence, as an investor, it is important for you to understand that the path to earning healthy returns is through finding stocks that boast of a strong business model, sound management and attractive valuations. Once that is done, investors then need to be disciplined and not succumb to pressures of constantly entering and exiting stocks.

How frequently do you churn your portfolio? Do you think that you will generate better returns on your portfolio if the churning is reduced? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
The fact that India's industrial production continues to languish in the red just shows how urgently the country needs reforms process to start kicking in. Indeed, construction, industrial and mining sectors have been severely impacted and various key projects have been stalled. Once the new government comes into force this week, it will have quite a task on its hands to get the Indian economy out of the slump it has sunk into. But that is not likely to happen overnight. Once the new government assesses the situation and does come up with key reforms for development, it will have the much bigger task of implementing the same. We hope that the new government is upto the task in this regard. Because the reforms process is the only way forward for sustainable growth and the not just the lowering of rates by the RBI.

Will the new govt. fuel industrial production growth?

Editors Note: There's more to getting wealthy than investing in stocks... to learn American wealth coach & Daily Reckoning contributor Mark Ford's wealth building strategies check out his 11 Secrets to Building Wealth (free access).

Every trend, no matter how long, has to eventually come to an end. Thus, if one is assuming the US dollar's status as the world's reserve currency to last forever, he better give it a serious thought. For the weaknesses or rather the departure from this trend is already beginning to show. And the challenger is none other than the Chinese Yuan. The US policymakers seem to be themselves admitting that the Chinese currency could one day compete for a place alongside the mighty dollar as a reserve currency. The journey is going to be far from easy though. First and foremost, China will have to implement radical financial reforms and make its exchange rate more flexible. It will have to show a commitment to move to a market determined exchange rates. This could then provide for more balanced domestic growth and global trade. It is clear that for the Chinese currency to become a potent force, it is not enough that its manufacturing engine alone fires. Other areas of the economy will also have to chip in. And it is on this development will the outcome of its ability to take on the might of the US dollar rest.

The US Federal Reserve has been adamant about its stance of not raising interest rates. The reason had more to do with two statistical numbers than the central bank's confidence in the economy. The US Fed reiterated that the inflation number was well below its comfort zone. Also the unemployment level continued to remain high. Hence the Fed chose to not acknowledge its flawed stimuli programmes. Instead, the central bank rejected concerns about liquidity stoking inflation. However, it now appears that the concerns about inflation were all but real.

As per Moneynews, global economists are of the view that inflation in the US will eventually rise. The rise in income levels and higher rent payments are expected to contribute to higher inflation. In the absence of higher interest rates, the runaway inflation could hurt the US economy. And while the US is taking a measured approach to unwinding the QE, emerging economies will have to remain prepared for higher inflation and interest rates in the US.

If one goes by the exit poll verdict, Narendra Modi is all set to occupy 7 Race Course Road. Markets have rallied on Modi wave and hit an all time high postulating that a reformist government under decisive leadership will bring India out of economic mess. However, a victory for Modi could well mean challenges for RBI governor Rajan as far as managing balance of payment and inflation is concerned.

A clear electoral mandate towards Modi can further lead to a huge surge in foreign institutional investors (FIIs) inflow. This can lead to significant rupee appreciation and hurt export competitiveness. Further, a torrent of liquid money into India will sow the seeds of inflation. This could well leave Rajan helpless. If he buys dollars and sells rupee to restore export competitiveness, inflation will rise. If he lets rupee appreciate, export sector will be affected. Hence, it would be interesting to see how RBI manages the inflation and rupee expectations once Modi comes to power.

However, we feel this is not a bigger concern as it is made out to be. Rising FDI and FII flow is more of a reflection of how domestic economy performs. Thus, currently, investors are pricing in that growth in India will rise under Modi's tenure. Also, rising foreign inflow will help us build forex reserves. Again, imports will get cheaper amidst rupee appreciation which shall narrow current account deficit. This can certainly be beneficial to India and is attributable to the Modi factor. There is no denying that there are too many expectations from this new government. But it's because this was an election of hope. Only time will tell whether this hope can turn into reality or not.

While stocks in India and the US continue to touch all time highs, it is quite possible that investors would forget about other asset classes. But then, does it make sense to participate in this rally in present times? Bargain hunter Jim Rogers does not seem to think so. Instead, he believes that depressed markets such as Russia, China and Japan provide better opportunities.

Discussing his views on gold and silver, Mr. Rogers believes that the many uncertainties will drive their prices going forward. The key ones being rising inflation (due to the unprecedented money printing activities by central banks across the world); the possibility of a war breaking out (due to the various economic problems and food shortage situations that could arise), or the global debt problems. He hasn't ruled out the possibility of governments confiscating money from bank accounts; which is why holding gold and silver would make sense as they would provide protection against the latter.

While he is in no rush to buy gold currently, he hasn't sold any of it either. Given the way that high expectations of a broad based recovery are being seen, he hasn't ruled out the possibility of the yellow metal correcting from here on. Keeping all of the above in mind, we believe gold should form an integral part of one's portfolio as a hedge against the many uncertainties. An exposure of 10 to 15% of one's portfolio would be advised.

The Indian stock markets continued to rally after exit polls signaled a majority for Modi led party. At the time of writing, the benchmark BSE-Sensex was up by 354 points (+1.5%). Barring pharma, all sectoral indices were trading positive. Capital goods & consumer durable stocks were the biggest gainers. Majority of the Asian stock markets were trading positive led Japan. However, Singapore and Chinese indices were trading weak. Most of the European markets have opened the day on a strong note.

 Today's investing mantra
"Cash combined with courage in a time of crisis is priceless." - Warren Buffet

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7 Responses to "Will you earn better returns by not being too active?"

parimal shah

May 15, 2014

I do not believe that Modi victory and large FII inflows should be a problem for Rajan. The money can be used for infrastructure development while the government goes on selling long term tax free inflation indexed infrastructure bonds in INR. This makes it a win win for all. This will ensure adequate funds for infra for long term, reduce CAD, and increase dollar reserves. Retired people will benefit the most from these long term infra bonds.


RS Rathore

May 14, 2014

2/3 years holding in any stock can some times turn the life blissful.


RS Rathore

May 14, 2014

I do not agree to Mr. Bogle's statement to earn wealth in long-long 60 years of 6 decades. If any one hold equity stocks for such a long period, his lucrative earnings can be called as USELESS. NO one can enjoy & relish the life at old age.



May 14, 2014

Hi, The rationale behind the statement 'end up pocketing 80% of the return' in context of the US market is as follows: US$ 1,000 invested at 8% gives you US$ 148,780 at the end of the 65 year time horizon. But because of costs of 2.5%, the return comes down to 5.5% So, what you get at the end of the period is US$ 32,465, which is a reduction of around 80% for investors.


S Gokhale

May 13, 2014

It is absolutely true.

I recommend all to watch "Wolf of Wall Street". Don't bother about the sleazy scenes of first few minutes, just wait till the scene of lunch with Leonardo. It is an eye opener.

The lesson learned is practice masterly inactivity and your portfolio will give better returns.


Sunil Doshi

May 13, 2014

5MWrap Up has erred in Maths today(13/5/2014)here :-
"but end up pocketing around 80% of the return. "
2.5% on 8% is 31.25%only.
Even at net return of 5.5% the cost is 45.45% & not 80% to which EQM wants to agree.
Also, Indian Stocks have give historic return of more than 14%. So, cost is less than 20% in India.


parimal shah

May 13, 2014

Absolutely excellent guidance/reminder at perfect time.I was also doing same thing but since I learnt lot from EQUTYMASTER various reports for more than 3 years, I forgot those short term transactions.

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