Oringinally from Kolkata, I am an analyst working at a financial services firm in Bangalore that caters to clients that are PE/VC funds, SWFs, investment banks, family offices, etc.
I’ve always had long drawn discussions with my father about how investing for the long term is what your goal should be and how short term returns come and go easily. His logic behind the same is backed primarily by the following reasons:
If you invest for the long term and don’t check your holdings everyday, you end up reducing how fickle you are and implicitly increases the level of conviction you have in your investments. This, in the long run reduces the long run volatility of the markets.
Investing for the long run reduces the liquidity at your disposal, this makes you more accustomed to a lifestyle where you don’t increase your daily expenditures, learn how to live happily with less. This also results in increasing your loss taking appetite.
Investing long term helps reduce the mental pressure of thinking about what more you can do with your money, because sometimes, not churning your portfolio is all you need to do to gain mental and financial wealth.
Despite believing in these points and conveying it to his son, he still is actively involved in F&O trading, which shows how greed for a quick buck is what still rules the best of us.
You have always been vocal about the fact that you don’t promote credit, derivatives or intraday trading for your investors because you’re in this for the long run and you know that for your investors to survive with you in the long run, they need to be aware and stable in their practices.
This brought about a question in my head, a general wondering of sorts:
Don’t you think that if people really start thinking long term, transition from trading to investing, it’ll be counterproductive for your business?
I had an analogy where I would love you to share your views:
In a country like India, markets are not as efficient as in the US. As a result, the level of risk exposure one gets by investing in a PE fund in the US is similar to what one can get by investing in small cap listed equities in India. This helps investors get exposure to comparatively higher alpha opportunities at a lower ticket size and higher level of liquidity as compared to the US. People tend to look at investments based on the security type but not in terms of risk, which I feel would rather act as a more efficient base for comparing returns.
Would love to get a chance to get your views on this.
Many customers decide to trade risky products with leverage with the wrong expectations that money can be earned easily and quickly. This problem has been accentuated by many claiming to generate large amounts of trading profits on social media. We have used every opportunity to create awareness that in the long run (3-year period), less than 1% of those who actively trade equity futures and options generate returns higher than bank fixed deposits or 7% annually. We will start sharing more granular information in the next few weeks. Generating profits from active trading is as hard as generating profits while running a business, if not harder, given that anyone can start trading and not everyone can start a business. The odds of succeeding when actively trading are very low, similar to any other walk of life, which requires skill, hard work, and some luck to succeed. From running a business to playing sports or music for a living.
Across our customers over the last many years, we have seen that higher the leverage the lower the chances of profitability. The profitability numbers are much lower in case of equity F&O as most trading happens in options, especially buying options which is the riskiest and the most leveraged product. We had shared this post last year on things to keep in mind while buying options.
While it might sound counterintuitive to hear this from the CEO of a brokerage firm which relies on active trading for revenue, I think a customer who remains active for many years by doing well in trading, even if not generating revenue in the short term, is a lot more valuable to a brokerage firm than customers who trade aggressively with wrong expectations and then become inactive. So when we look at our business, we think we should do whatever it takes to help the customer do well in the long run, even if it means a reduction in revenue in the shorter term. By helping set the expectation that stock markets aren’t a place to make quick and easy money, we can help the customer be risk averse, leading to better decisions with money.
As a business, we have to question the reason for our existence, it was various things in the journey, but today I think we exist only to help our customers do better with their money. If our customers do well, I think the business will automatically do well. Would it be a revenue hit in the short term if people traded lesser? Yes absolutely! But if you think about it with a 5 to 10-year view, if your customers trading lesser led to them taking much lesser risks which led to them sticking around, a lot more than the short-term revenue loss can be earned in the long run. An active customer also tends to talk about the product to friends and family and help in the business grow.
The problem with capitalism in today’s world is that everyone is thinking very short term, three months to 1 year, and prioritising the short term over the long term. But I think, ideally, it should be the other way around. Of course, I can say this because, as Zerodha, we don’t have external investors and hence don’t have an obligation to grow at a certain speed every quarter or every year.
I agree. One of the essential skills required to do well in business and investing is understanding the risk-reward payoff and then adjusting the asset allocation based on personal preference. Playing poker is a good learning ground for this.
So, as amateurs who, other than investing, learn from publicly available opinion pieces such as podcasts & articles; what should one do in order to map their risk appetite?
The doubt arises because in practicality, I have observed that it’s difficult for an investor to build conviction in securities based on one’s risk appetite. This is because we are prone to value traps and tend to reason our investments with the logic that in the long run, it’ll be a profitable investment (But in the long run, we’re all dead). This leads to a falsely optimistic perception of one’s stock picking skills.
We are in the middle of maybe the biggest bull market in Indian history, and making money investing in the markets has been relatively easy for the last few years. While many assume it is their skills or strategies, it is mainly being at the right place at the right time. The content available out there is an extension of this and hence can be misleading.
Each one of us is different and our reaction to risk is going to be different, so I guess mapping out risk appetite is a self-discovery process. For example, from when I was trading and today, even as a business (especially running Rainmatter Fintech investments), I usually enter any trade/investment thinking of the worst-case outcome and if I can make peace with it if that happened. If I think I can, I invest, if not I don’t. Helps me stay rational afterwards. I think the most important thing here is to do whatever helps you stay rational when shit hits the fan, usually, that is when humans do maximum stupidity. One stupidity is enough to undo all the good done for decades. This works for me, but may not work for you. I guess it is about figuring out what helps you stay rational at all times, i.e mapping your risk appetite.
For most people, being more conservative than aggressive is the right strategy. We had shared something on this topic, check this.
