Get rid of your bad investments now

Several investors believe that money can be made by buying the right investment at the right time. If they select a good investment and time their decisions well, they think it's enough. They never tire of ruing the investing opportunities they've missed. However, the same attention is not paid to the bad investments in their portfolios. In reality, an investor's portfolio suffers more due to the incorrect decisions that are not acknowledged and corrected. Holding bad investments may be worse than not selecting the right ones.

While the entire universe of investments is potentially available for buying, the decision to sell only involves what the investor already has. It is, therefore, pragmatic to focus on holding the best rather than wondering about what we may have missed.

According to behavioural economists, one of the main reasons for our refusal to sell an investment is our aversion to loss. If our investment turns out to be good, we are happy to sell and feel good about the gains. However, booking a loss is painful, so we tend to postpone the regret we feel at having made the wrong decision. We choose to wait out, ignore, or worse, add more to a poorly performing investment, hoping to average out the cost. Therefore, cleaning up a portfolio is a tough task and calls for rational decision-making. Here are three ways to discard the bad apples from your portfolio.

The rate of return of a portfolio is the weighted average of what we hold in it. If some of our money is stuck in bad investments that show a negative growth, or don't work as hard as the others, we are losing out on the overall gains. If the money from a bad investment is released and redeployed, it may end up doing better.

If we are reluctant to make the decision, it may help to begin with a partial liquidation of the investment that is performing poorly and comparing it over a period of time. When we see how the loss could have been arrested and funds redeployed, we may be able to rebalance the portfolio with greater confidence. For example, those who are still holding the JM Basic Fund bought in 2007 in the hope that they will recoup the loss, should liquidate the fund and pick an index fund to see the benefits of selling what is not working.

We also have to give up the urge to come out good even after we know that our investment decision was bad to begin with. Ignorance is not a pardonable error in investing and when time reveals our decision as a bad one, it is better to act than argue. An endowment policy that was bought to save taxes, a Ulip purchased assuming that it is an investment for a fixed period, low-priced stocks picked at market peaks when good stocks seemed expensive, NFOs bought on an erroneous understanding of the product are all bad investment decisions, ab initio. They will not become better with the passage of time.

However painful the decision, we may have to book the losses arising from the purchase of a bad product. The sooner it is done, the better it is for the investor. Many of us think we should recoup something from the investment. If the performance is poor because the market cycle turned down, it may be worthwhile waiting for an upturn. If the market improves and our investment fails to look up, it confirms the bad choice and the need to quit.

Several investors want to know when to sell and ask frequently about profit booking. The crux of good wealth management is in wisely booking the losses and having a strategy for weeding out bad investments. If such investments are recognised for their draining impact on the portfolio and are uprooted ruthlessly, the fruits of investing are bound to be sweeter.

5 Mutual Fund Myths

It is easy, even for an intelligent investor, to be taken in by the hype surrounding a mutual fund scheme. Such misconceptions can impact the investments, which is why they need to be debunked. Here are the five common myths:

1. A fund with a net asset value (NAV) of Rs 10 is cheaper than the one whose NAV is Rs 50: The NAV of a mutual fund represents the market value of all its investments. Any capital appreciation in the fund scheme will depend on the price movement of its underlying securities. Suppose you invest Rs 1,000 each in Fund A (a new scheme with an NAV of Rs 10) and Fund B (an older scheme with an NAV of Rs 50). You will get 100 units of Fund A and 20 units of Fund B. Let's assume that both the schemes invest in just one stock, quoting at Rs 100. If the stock appreciates by 10%, the NAVs of the two will rise by 10%, to Rs 11 and Rs 55, respectively. In both cases, the value of investment rises to Rs 1,100-an identical gain of 10%. Fund B's NAV is higher as it has been around for a longer time and had bought the scrip earlier, which appreciated. Any subsequent rise and fall in the funds' NAVs will depend on how the scrip moves.

2. A balanced fund will always have a 50:50 debt to equity ratio: Balanced funds aim to achieve a balance between equities and debt. But the balance can tip depending on the nature of the fund. The equity-oriented balanced funds usually invest at least 65% in equities and the rest in debt. The others do this in a 40:60 ratio.

3. Large corpus funds generate higher returns:  A fund with a very large corpus is prone to inefficiencies as rising assets become unmanageable after a point. Also, most fund managers are more dexterous managing mid-sized funds. A large fund forces them to broaden their stock universe. This can lead them to include less researched or low-potential stocks in the fund's portfolio or increase the stake in certain stocks, leading to a selection bias. HDFC Equity has a corpus of Rs 2,680 crore, but its three-year annualised return is -1.68%, whereas the best performer for the same period is Reliance Regular Savings Fund, with an annualised return of 7.71% and an AUM of Rs 618 crore. At one-fifth the assets, the Reliance fund has fared far better.

4. Funds that regularly declare dividends are good buys: Fund houses declare dividends when they have distributable surplus. However, there are times when fund managers declare dividends as they do not have adequate investment opportunities. In some circumstances, a fund manager may sell some quality stocks to generate surplus for dividend distribution to attract investors.

5. SIP always scores over lump-sum investing: A systematic investment plan (SIP) is the best way to invest during volatility as it lowers the average per unit cost. This is also termed as rupee cost averaging. However, investing systematically during a bull run results in lower returns. When markets are constantly rising, SIP fails to lower the average cost and so results in lower returns compared with a lumpsum investment.