Avoid Getting Robbed Of Your Returns

As an investor you may face different types of challenges in the current globalized world where markets and thereby investments are linked. As a fund investor, your life is even more complicated when you have to select between plethoras of different funds offered from various fund houses. You have an option of investing in open ended or close ended funds or equity, debt, commodity or international funds and many different categories within each of them. Having said all this, it is important to answer that critical question as to which is the best category of fund for you? Rather than looking at the positives of each fund, I will look at the different “investment robbers” and how each fund protects and guards you against each of them. The fund which protects you from all the Investment Robbers is the Fund which is best suited for you. 

Investment Robber # 1: Inflation 

Inflation is one of the biggest and the most silent enemy of any investor. In fact, it is that monster which many investors don’t even recognize. Many people believe in “saving money” and mistake it for investment. However, they fail to recognize and appreciate one important fact that “saving is not investing”. Never mistake saving for investments, else you will surely be in for a rude shock. You would probably be living in a big delusion because you don’t understand the rules of money. 

The rules of money were permanently altered in the year 1971, when the then US President Richard Nixon took the US off the gold standard and granted itself the license to print money. Since then, the US Dollar and other world “currencies” have depreciated while the price of all commodities measured against it be it precious metals like gold, silver or industrial metals like steel, copper, aluminum or agricultural commodities – have gone up and will continue to go up over the long term. 

Hence, inflation is the Investment robber number 1 against which the fund has to protect your investments. Debt funds don’t offer any protection against this investment robber # 1 called inflation because bonds and money market instruments primarily invest for coupon interest or accrual which is not capable of protecting your money against deprecation in the value of money due to inflation. This is primarily because, these kinds of investments only offer current income and are not capable of providing growth income which will shield your investments against the monster of inflation. Equity funds certainly offer you protection from inflation as they are invested in companies whose earnings are supposed to grow. Also, gold funds would offer you such kind of protection because it is an inflation hedge. But then do they protect you from the other investment robbers.

Investment Robber # 2: Income Tax 

The government is the biggest investment robber of all. It systematically and legally takes away money from your pocket at all the stages of your dealing with it. Be it savings, spending, investing or insuring, the government is always standing there to skim you off your returns. Most of us are aware of the threat of the taxman but are not aware of how to actually protect our hard earned money from him. The biggest dent in your pocket is inflicted by the government when you earn a return on your investment, as it conveniently taxes it. For example, interest on a bond is fully taxable in our hands at the marginal rate of taxation. As far as mutual funds are concerned, all the debt oriented products are taxed, and hence, pure debt funds will not protect you from this “Investment Robber # 2”. Equity funds offer you that protection in the form of tax free dividends and long term capital gain being exempt from the purview of the taxman, but then do they protect you from the other investment robbers. 

Investment Robber # 3: Interest Rates 

Another big enemy of your investments is the interest rates. In fact, interest rates are such a big enemy that it affects both debt and equity investments. When interest rates rise, bond prices fall and so does the NAV of your Bond Fund. Again, when interest rates rise, equities as a general rule fall because the earnings of companies drop due to high finance and interest cost, equity valuations contract due to rise in the discount rate and high interest rates result in reduced fund availability for equities as debt competes with them for the same investor’s wallet. Therefore, both debt and equity funds would not be able to protect you against this investment robber # 3 of interest rates. Gold would in all likelihood be able to protect you from this investment robber but would it be equally effective against the other investment robbers. 
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Investment Robber # 4: Market Volatility 

Investment robber # 4 would be “market volatility”. Prices of all market determined products, be it equities, bonds or gold, would fluctuate and remain volatile with day-to-day price movements. Yes, the price of an accrual product like a liquid fund would certainly protect you against market volatility but then it would not protect you against investment robber # 1, “inflation” and investment robber # 2, “Income Tax” as well as investment robber # 5, which is to follow. So which kind of investment has the wherewithal to save and protect you against all the investment robbers, including the dangerous market volatility? 

Investment Robber # 5: Incorrect Asset Allocation 

The importance of asset allocation can be understood by only one statistical fact where Ibbotson and Kaplan have shown that 90% of portfolio variability is due to asset allocation. This means, only 10% of the variability in portfolio performance is due to individual holdings, while 90% of it is determined by how the funds have been allocated. William Bernstein in his book “The Intelligent Asset Allocator” has said that “there are two kinds of investors: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know”. Therefore, a cardinal principle of investment is, which of course may seem bad news to many is that, the only thing which is in your control is asset allocation because that is what you have a full control on. However, neither do equity, bond or gold funds offer you this kind of protection against Investment robber # 5 of “incorrect asset allocation”. Then who indeed does? 

The Fund that protects you from all Investment Robbers 

And the fund that protects you from all the Investment robbers does not require any knowledge of rocket science to guess. It is a simple age old fund called the “Balanced Fund”. Confused? Let us see how a Balanced Fund indeed protects you from all the different Investment Robbers. 

Protection from Investment Robber # 1: 

Inflation – A Balance Fund invests both in equities and debt. The equity component in the Balance Fund protects your money and investment from the big silent monster of inflation. 

Protection from Investment Robber # 2: 

Income Tax – A Balance Fund is treated as an “equity fund” as far as taxation is concerned and hence on one hand its dividends are tax free while on the other hand it is outside the purview of long term capital gains tax. The beauty of it is that, even the “debt portion” of it becomes tax free as equity which does not happens in any other case. 

Protection from Investment Robber # 3: 

Interest Rates – A Balance Fund invest both in equities and debt. The equity component in the Balance Fund protects your money and investment from the dangerous killer of interest rates. 

Protection from Investment Robber # 4: 

Market Volatility – Since a Balance Fund invests in both equity and debt all investments move through the “Investment Cycle” -when one asset class is in a bear market most probably there is some other asset class which is in a bull market. Therefore, a Balanced Fund, as the name suggests, balances and evens out market volatility by providing you with the best risk adjusted returns with minimal market volatility. 

Protection from Investment Robber # 5: 

Incorrect Asset Allocation -This is perhaps the most important protection offered by a Balance Fund. As explained earlier, the key to long term superior investment performance is asset allocation and what can be better than a Balance Fund, which has allocation to both equities and debt. Further, it always by definition buys the cheaper asset and sells the costlier one when one asset class out-performs the other so as to bring the fund back to the optimal asset allocation. Therefore, it automatically by definition follows the most important principal of investment – Buy Cheap and Sell Dear. 

To conclude, the name of the Fund is Balance but it is the most imbalanced of all the funds as it takes the credit of protecting and shielding your money of all the five investment robbers. So the next time you see a “Balance Fund” don’t just brush it aside because remember that whether it is investments or life, a simple and balanced approach always works. All the best in your balanced approach towards investments and life!