Yesterday I received a call from new investor (He got my ref from my existing Investor) during entire call he was complaining that “you all IFAs are good Story Teller but when it comes to performance you all are below average. My earlier IFA was telling that you may get The Power of Compounding in Mutual Fund if you keep your horizon long but today, keep compounding a side, normal FD interest is also not coming after 10 long years, which is not a short term.” Why The Power Of Compounding didn’t work in my Mutual Fund Portfolio?
I think he was not wrong at some angle and his question / complaint is eyeopener for all of us. In current market scenario we all are facing the same feeling. Today we are going to discuss what is the reason Why the Power Of Compounding didn’t work in our MF Portfolio and what are the steps to be taken to get it worked?
At some point we all are good Story Teller, no doubt that for being a good advisor we all should be a good Story Teller but we should also know that we should commit that much only which we can perform. It is true that market is not in our control then we should try to generating proper returns and safety to the client’s investments.
Remember by Story Telling we can attract new clients but for hand holding that client for longer period will be decided by the gap between expectations of an Investor on his Portfolio and output of your Advisory Services on That Portfolio.
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Why the Power Of Compounding didn’t work?
First of all we have to understand what is compounding? Compound is exist in interest only. As per Wikipedia Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest. Compound interest is standard in finance and economics.
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Then What to do?
To experience the power of compounding we need to follow the definition of compounding interest i.e. the returns we earned should be added to the principal so we can earn more returns on the return
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But see what happens in our Investment?
In general, we are following the Buy and Hold strategy (Because of Authority Bias – Buy & Hold is the best theory) or SIP (Buying at every level – Again because of Authority Bias “SIP KARO MAST RAHO”) in investment. In both strategies we are very less concerned about market risk, Due to what we have earned a lot during the Uptrend, the entire Notional Gain converted into Notional Loss during the downtrend (Market Correction). Which keeps us away from experiencing The Power of Compounding. See the table how quickly our profit vanished during the disruptions in the market.
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How we can experience The Power of Compounding?
Now, this is a big question How can we change the experience? We have to work hard for experiencing The Power of Compounding, and for that, we have to correct our way of investing. If we define a proper profit booking strategy to save our profits at a certain level and redeploy it at a comfortable lower level then only we can experience The Power of Compounding. For this again we have to come out of the Authority Bias. We have been told that “We should not do the timing because can not” by the Authorities of the industry.
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How does it work?
We can see the following chart and see that Time In The Market is one which affects most to your investment value but when it combines with Timing The Market the portfolio generates more Returns with Safety and experience The Real Power Of Compounding.
In the above chart, you can see the effect of compounding which investor wants to see in their portfolio. It looks that SIP is generating Simple Interest and Real feelings of The Power of Compounding are seen in Strategy with Risk Management [TAAP-SIP].
We will never be able to experience The Real Power of Compounding to our clients by just Stay Invested (Buy & Hold Strategy). Due to this investors become annoyed and start unexpected behaviour.
This becomes a big problem for us and that will be the topic of our discussion for My coming Blog Post “How to manage Investor’s Behavior“.
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