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Mutual Funds:- Honest Review

February 9, 2022 by Laxman Sonale 2 Comments

Hello friend, I am Laxman Sonale, In this article, we see Mutual Funds: an idea of when time has gone from chapter 9 of the book Stock to riches. In this Parag Parikh Explain the mutual fund industry and also the fund manager problem, as well as the destroyer environments. So let’s understand the most famous industry in finance.

Previous Chapter 8

Chapter 9: Mutual Funds: an Idea where time has Gone

In this starting author explain the real meaning of Investing, If you think investing or stock market is some magical place and those take the risk on that they win and become very rich in overnight. then you can ignore this article right now.

But if you invest in mutual funds without knowing about them, and their behavior/psychology, then this article helps you most to understand this industry.

you want to learn about investing and avoid the big mistakes of financial life/in mutual funds then you must read with understanding.

so hope you get the notification. so let’s start this chapter 9

At the start, the author says, ” Investing is a game of patience, and investors get rewarded if they invest for the long term. the longer one stays invested the greater are the rewards. Buy a value, sit on it, and left time to do the rest.

In today’s changing time’s investors shun the age-old wisdom of Long term investing and chase the illusion of short-term quick profits. Keynes is often quoted – ” In the long run we are all dead” – to justify the speculative urge of Short-term quick profit.

the strategy of short-term is to time the market rather than invest in good sustainable business. sometimes you go night and make a quick buck. (Mutual Funds:- Honest Review)

But the game of Timing can be very difficult and it is hardly advisable when it concerns one’s hard-earned money. Everything changes but there are certain principles that do not change. the power of principles is that they are universal timeless truths. if we live our life based on these we can quickly adapt and apply them anywhere world, we cling to practices, structures, and systems for some sense of predictability in our lives. we forgot the principles and we are headed for trouble.

Investment management is a profession but it is being run like a business. So the rules of sound investment take a back seat and the rules of business dominate.”

then the author explains the beginning of the Mutual funds

The Beginnings of Mutual funds:-

In this point, the author explains the history of mutual funds, and how this industry is born.

the author says, ” This industry was created to channel the savings of a vast number of small investors into the capital markets. it Is a vehicle to safeguard the interests of the small investors who are assumed to be incapable of taking investment decisions on their own.

The Mutual fund industry provides the basic infrastructure for professional investors, in the form of professional fund managers investment research, business analysts, stock market analysis, and system to cater to the huge pool of investors. the aim is to fulfill the long-term investment needs of retail investors.”

the rule of the Game of mutual funds

Long term Investment Strategy
Investor friendly: Exit Within 24 hours
Professional fund managers with strong market expertise.
Backed by strong Research Analyst.

You also know about these rules, when you start investing in mutual funds, in the form of SIP. so this is the main rule, let’s see the deep game, from the fund manager side, to understand this, the author explains The Paradox concept

The Paradox:-

the author says, ” Most mutual funds talk about long-term investment strategy. however, they are open-ended and the investor can exit whenever he wants.

The paradox is that on the one hand it talks about a long-term investment philosophy but on the other, it does not encourage the investor to be a long-term player. (Mutual Funds:- Honest Review)

this is because the normal practice in the mutual fund industry is to have open-ended funds and the principle of long-term investment takes a back seat, the game is that of timing the market and looking for short-term gains.

In Fact, it would be wrong to assume that investors do not want their money looked in for long periods. If that were true then people would not invest in RBI bonds, or past savings schemes for five to seven years, or in the public provident fund, for 15 years.”

then author blames this industry, for many reasons, let’s see one by one reason

the author says, ” The industry itself needs to be blamed for nurturing and nursing the culture of open-ended schemes. As the industry grew so did the competition leading to high marketing costs.

Money comes when the markets climb as the net asset values start going up. there is a scramble to get in and fund managers are pressured to invest in a rising market at inflated asset prices.

However, pull-out(taking out money from mutual funds) forces fund managers to sell the portfolio at depressed prices to meet the redemptions.

the basic principle of buying when prices are depressed and others are selling, and selling when prices are high and others are buying is not workable. fund managers are forced to act in a way that does not conform with the basic investment principle.

fund manager’s decisions are being controlled by the environment.”

then author talk about the Fund managers Behaviour, if you invest in a mutual fund, then you should this following paragraph carefully to understand fund manager behavior

Fund Manager’s Behaviour:-

the author says, ” Because of the pressure to perform in the short run, fund managers chase each other’s net asset values rather than follow sound investment strategies.

When the information, communication, and entertainment (ICE sector) moved up in 1999, fund managers chased those stocks, and prices rose steeply. (Mutual Funds:- Honest Review)

Most of them had the same ICE stocks among their Top holdings. at the time of the rise of the public sector understanding in the oil sector, most of them had ONGC, BPCL, and HPCL as their top holdings.

then when the fed passed, they competed to sell and depressed the prices. it is obvious that the herd mentality is what drives them to make decisions.

newspaper and financial journals report quarterly performance of funds. Influenced by this news, investors enter and exit funds forcing fund managers to change strategies midway. they are thus forced to keep up with market trends and this affects their performance.

Also, the practice of offering bonuses and rewards for turning in short-term profits rather than for following a sound investment strategy forces them to adopt short-term strategies. as a result, it is the investors who lose.

For if making short-term money was so simple in the market he would not be a fund manager. he would be busy making money for himself playing the market.

This is not to say that all fund managers are mediocre. the Indian capital market does have some very good talent and we need to create the right environment for such talent to flourish and at the same time reap benefits for the mutual fund holders.”

after this, the author explains the destructive environment for mutual funds.

Destructive Environment:-

In this point, the author talks about the mutual fund environment.

the author says, ” the mutual fund manager manages the money of investors whom he has not even seen. it is the sales team and third-party distributors who bring in the investors. In a situation where fiduciary responsibility is very important, not knowing the investor whose money he is managing can call his commitment into question.

Mutual fund managers have a file of cash to be invested in the stock markets. naturally, broker company managements and other operators chase them with quick money ideas. with so much attention being showered on them,

there is a danger that they could overestimate their abilities and performance. Sometimes the rewards for performance could also make them overconfident. (Mutual Funds:- Honest Review)

It is true that we can not blame the fund manager but the point is when there are so many good professionals in the field, they should not be forced to operate in less than conducive environments.

The business of a broker depends upon the number of resources he is able to mobilize for the fund. hence brokers may try to sell a fund to investors not because it is a good investment but in order to generate business from the purchase and sale of stocks.

The fund manager and the broker please each other for their own benefit and in the process, it is the investor who suffers.

the development of the mutual fund’s concept was perfect for its time. the idea was to pool together the resources of investors and invest them in the stock markets.

Professional fund managers backed by strong research would handle the investments. thus the investor was assured of the services of professionals. but times have changed.

The level of education has improved. information flow has increased. The Internet enables the exchange of information in real-time. Online trading enables real-time execution.

Chat sites ( like our blog) help investors discuss their views and seek opinions. the power of knowledge has shifted from the hands of a few to those of the masses.

We now have a web of smart professionals with new ideas knowledge and operations as compared to a handful who are working for the mutual fund industry.

in fact, the concept of mutual funds has become outdated. mutual funds are competing with millions of traders. and with so much volatility and pressure on performance, they have also become weekly traders, if not day traders.

our belief that mutual funds are good is getting another example of a mental heuristic.”

then the author talks about mutual funds as a profession or business.

Mutual funds: A profession or A Business

in this point author puts both scenarios of the profession and the business

author says, ” Money management is a profession. the professionals who make it are validated by their performance. unfortunately, the advent of mutual funds has turned it into a business where the goal is to increase the assets under management.

today, funds compete for the size of assets, chasing a benchmark of relative returns. the aim is to beat the top-performing fund. Even a poor two percent becomes a benchmark.

On the other hand, a professional like a portfolio manager will benchmark against absolute returns because in most cases has fees are linked to his performance.”

then lastly the author gives the solution of mutual funds.

Mutual funds solution:-

in this author explain the different types of mutual funds, and which one is best, let’s see

the author says, ‘ Open-ended mutual funds are the main cause of the volatility in the markets today. I believe that close-ended mutual funds(is a type of mutual fund that issues a fixed number of shares of their own fund) are the best vehicles for a long-term investor.

it allows the fund manager to be disciples, which in turn reaps substantial rewards for investors. no doubt the choice of such funds is limited. (Mutual Funds:- Honest Review)

In this case, the price of the fund could fluctuate according to the net asset value, but when the units change hands they go from one investor to another and there is no redemption on the fund.

the fund manager, therefore, is free to make long-term decisions because the environment does not control him. for the healthy growth of the mutual fund industry, more such close-ended funds need to be floated.

however, the irony is that close-ended mutual funds quote at a premium prior to listing and at a discount to the net asset value after listing. This discount may be viewed as an expensive monument erected to the inertia and short-sightedness of the shareholders.

The price movements of close-ended funds display the fickle behavior of investors as investor sentiment varies over time.

When noise traders are optimistic, the price of the net asset value narrows. when noise traders are pessimistic, the price of close-ended funds declines, and the discount to the net asset value widens.

Investors in close-ended mutual funds are subject to two types of risk: firstly, the fundamental risk of the net asset value going down, and secondly, the noise trader risk of widening the discount due to pessimism. The opportunity arises in the second scenario.

However, the investor would need the patience to benefit from such an opportunity. But isn’t investing a game of patience after all!

then the author talks about the future of open-ended mutual funds,

you can read this in the book, by ordering on the following image link.

Mental heuristics In Stock market

February 6, 2022 by Laxman Sonale 1 Comment

Hello friends, I am Laxman Sonale, In today’s article, we see chapter 8 from the book Stock to riches ( mental Heuristics). In this chapter the author, Parag Parikh explains how our mind is working in real life as well as in the stock market. Especially when money comes. So if you want to avoid losing money, then read this article, and understand it carefully.

let’s start

Previous Chapter 7

Mental Heuristics:-

At the start of this chapter, the author gives the two questions to test our mental heuristics, hey guys questions are so funny and logical, let’s see

Question 1:- Three birds are sitting on a tree, two decide to fly away. How many birds are there on the tree?

Question 2: Observe the following picture which line appears longer?

The bottom line appears longer but if you look at the diagram below you notice that both the lines are of the same length.

To support the above statement, the author gives the following diagram

the author gives the right answer to the first question

the author says, ” Although both the lines are the same why is It that the lower line appears longer? that’s because the brain takes a shortcut when processing information. I do not process all the information and this leads to biases. this process is known as mental heuristics.

If your answer to the first question- How many birds are there on the tree!- is one,

then you have fallen prey to mental heuristics. your brain does not the information properly. The answer should be three birds. Two had only decided to fly away.

They did not fly away had I told you that they flew away then you would be right.”

The first time I read it, I am also falling in bias

then the author gives the definite definition of mental heuristics and explains mental heuristics with examples

the author says, ” the dictionary definition of the word heuristics refers to the process by which people reach conclusions usually by trial and error.

This often leads them to develop thumb rules, But these are not always accurate. One of the greatest advances of behavioral psychology is the identification of the principle underlying these thumb rules and the errors associated with them.

in turn, these rules have themselves come to be called heuristics. In short, the following four statements define heuristics bias

People develop general principles as they find out things for themselves.
People rely on heuristics to draw inferences from available information.
people are susceptible to certain errors because the heuristics used are imperfect.
People actually commit errors in a particular situation.

Then the author gives examples of this

the author says, ” there is a newly opened megastore in the vicinity whose stock is listed on the stock market. you see a big queue outside it and you think it must be doing a roaring business.

You buy the stock hoping it will go up because the store is doing well. But there could be umpteen reasons for the queue the store definitely could be doing great business. But it is also possible that customers are queueing to return defective goods or perhaps the service is slow, or maybe all the other stores in the vicinity are closed on that day.

There are various reasons for the queue but our brain does not weigh all the probabilities and makes a decision on half-baked information.

Stock markets are interesting because Investors do this all the time.

then the author explains with reliance industries limited ( RIL) examples

the author says, ” when the company discovered a gas vein. the stock jumped as investors cashed in on this news. But let us analyze the situation without falling prey to mental heuristics.

the gas source was discovered but there were other factors to be considered the quality of the gas, the number of wells to be drilled, the time it would take, the plans to finance the project, etc.

Before the profits could be repaid yet analysts predicted the future profitability of RFL and on such hopes, investors bought the stock at rising prices.

This is how mental heuristics work when the brain does not process all the information and its implications. the tech boom was built on the same logic and we know the damage it has done.”

then author explains why we do this time by time,

the author says, ‘ Evolutionary forces shaped human cognition over centuries. that served our ancestors well, allowing for quick quality decisions.

Today, the complexities of our lives throw up multifarious data that sure minds may not assimilate very easily. The heuristics we help carry associated biases, which undermine the quality of our decisions. let’s take a look at some heuristics and their biases.”

then the author explains different heuristics

let’s see one by one

Availability heuristics:-Mental Heuristics

In this, the author says, ” One bias associated with availability is the ease of recall.

We are more likely to make judgments based on recent or easy-to-remember events rather than other similar but harder to recall instances. the flow of information around us is what happened in the India shining story of 2003-04.

All available information press, television, bureaucracy, business, and political circles, centered on the positive aspects of the Indian economy.

No negatives were permitted. shared by so much optimism the herd mentality comes into play and everyone not only believed the story, they advocated it.”

then the author explains, how these availability heuristics work in the stock market

the author says, ” this was reflected in the stock markets, the senses jumped from 2800 in April 2003 to over 6000 in April 2004. the NDA and its allies were sure they would win the electrons as the India shining story pointed a rosy picture of their governance. come May 2004 and the electron results announced that the NDA government had lost. How did this happen? the post-analysis revealed that the India shining story had been aggressively sold in the major cities; hence the exit polls in these cities placed the NDA’s chances very high. But 70 percent of the population lives in rural areas and for them, India was not shining. thus NDA was lost. (Mental Heuristics)

On may 17, 2004 the markets crashed by more than 800 points in just two days.

The reason:- All available information was negative. In bull markets, there is only positive news and in bear markets, it is only negative. that’s why markets go up or come down on reflexivity.”

then the author explains other heuristics, let’s see how they work in the stock market.

Representative Heuristics:-

In this, the author says, ‘ We assess the likelihood of an event by its similarity to other occurrences A predominant bias associated with this is an overreaction.

In the stock market, if the leaders report impressive performance, then all the stocks in that particular sector benefit.

the fortunes of the steel industry seemed to be changing and TaTa steel reported increased earnings profits. All the stocks in the sector including the junk and penny stocks attracted investors interest irrespective of whether they too would report increased earnings when the textile industry reported good profits, not only did all the stocks in that sector rise but companies in associated industries, like machinery manufacture, spinning mills, dyes, and chemicals also attracted attention. (Mental Heuristics)

Representative heuristics also affect investors’ actions. Investors try to replicate their portfolios by following the leaders. if they find that a leading find or broker or a respected personality has bought a particular stock they also buy the stock. in a way, this gives rise to the herd mentality.”

then the author explain saliency heuristic

Saliency Heuristic:-

In this, the author says, ” Individual over regret to un unusual event assuming it to be a permanent trend. Two airplanes crashed into the world trade center and the world stays flying the next day. Surely this type of incident has the next day. On the contrary, the next day was probably the safest time for flying.

In bull markets, analysts overreact to unusually good quarterly earnings assuming it would be repeated in the future and become bullish on the stock. In the bear market, they overreact to a bad quarterly estimate extrapolating it too for the future.

In 2004 second-quarter GDP growth estimates of 10 percent saw the markets going up on the assumption that the trend would continue. Actually, it needs to be sustainable to justify good times ahead, however, this is how saliency heuristic works with investors.”

then author gives overconfident examples, you can read this in the book, buy this book from the following link

then the author explain herd mentality with example in the stock market.

Herd Mentality:-Mental Heuristics

in the author says, ” Prakash bought a Maruti Western after carefully researching the decision. He was very happy with it and, enjoyed driving the car on his long haul trips to Lonavala. After a few months, a flood of strangers approached him and offered to buy the car at reduced prices.

The vehicle was in good condition and had done a few thousand miles. Worried that he had not made the right decision Prakash considered selling his Maruti at half his cost price. should he sell the car?

Before you answer, ask yourself what advice would you give him if he wanted to sell 1000 shares of Maruti, which he had bought for Rs. 400 and was now quoting at Rs. 300 due to depressed stock market conditions.

The history of the stock market shows that most investors buy stocks in companies or mutual funds for presumably sound reasons but exit their holdings the moment the market turns against them. (Mental Heuristics)

they sell when a bunch of complete strangers offers them less than what they had paid. Conversely, they will pay high prices for stocks or real estate, or paintings just because other people whom they don’t even know are willing to pay such prices. The dot-com boom was a result of such thinking.

In Stock market Parlance this is known as investing with the herd. We need to understand the manner in which the value of a stock or commodity is determined. To some extent what other people think matters a great deal.

Beauty may be in the eyes of the beholder but the value is often in the eyes of the buyer. If Prakash wanted to sell the Maruti then it was worth what the buyers would pay for it. But if he didn’t then he was the only one to decide the value of his car.”

then author explains how herd mentality work in the stock market

the author says, ” In the stock markets most often investors allow popular opinion and behavior to define value for them; sometimes for the good but often not their buying or selling decisions are made not on the basis of their own convictions, but on the value that strangers appropriate.

The Herd mentality affects business decisions to a great extent people try to replicate the leaders. In the end everyone behaves alike which leads to cutting prices for market shares. This is very common in the stock brokering business.

Technology has made it easy to install trading terminals across the country. So to survive in a competitive market, brokers have lowered their trading commissions to as little as 3 paise. the difference between one broker and another is the difference in their commissions, not in the value they offer their clients.

that how herd mentality works in business.”

after this, the author gives the size bias

Size Bias:-

In this author talk about two friends, that invest in the market with different time frame, let’s understand size bias.

Two friends, Gautam and Salman, are just out of college and have taken up jobs. from day one Gautam sets aside Rs. 300 every month, which earns him 10 percent per annum, after 10 years he stops as he has started a family.

Salman got married early and did not save anything for a long while. After 10 years, he began to set aside Rs. 300 every month earning him 10 percent per annum.

He continued doing this for the next 30 years until he retired at the age of 60. Salman’s investment was Rs. 1,08,000 while Gautam’s was only Rs. 36,000

When both retired who has more money? it would seem to be Salman as he has been saving for 30 years. in reality it was Gautam. (Mental Heuristics)

At 60, Gautam got Rs. 1,051,212 while Salman got Rs. 621,787. This is the power of compounding which investors normally forgot.

Salman could not make up for the 10 years that Gautam’s money compounded at an annual rate of 10 percent per annum.

We often tend to look at the big numbers and ignore the small ones.

In money matters, it is the small figures that make all the difference.”

After this author gives the wonderful advice to the trader, how their mind works, and how they recognize patterns.

this you can read in this book, buy the book from the following link.

So this is all about chapter 8 on mental heuristics from book stocks to riches by Parag Parikh.