Monday, July 23, 2012

The transition from being savers to investors

It is virtuous to save. This is what we were told when we began to earn money . We repeat the same lesson to our children. We seek protection, assurance, promise, safety and all those comforting outcomes from the money we have saved, and we fail to see ourselves as investors. So, what does it take to transit from being savers to becoming investors?

First, savers are hoarders. They accumulate assets that make them feel they have something of lasting value. The marked preference for gold and property does not come from some astute understanding that these assets grow in value over time. It is not uncommon for savers to be proud of the property bought for 50,000 with tremendous foresight, 25 years ago, and which is today worth 20 lakh. To the investor, this is an asset that has grown at a compounded rate of 16% over years, but if the value is not realised in any manner, it's worth so little. To the saver, selling off such a valuable property is sacrilege. The transition to becoming investors requires the mindset to view assets for their economic value, and plan who will realise that value, how and when.

Second, savers are focused on outcomes , not processes. They are thus gullible to fraudulent packaging of financial products. Several gave their money to dubious schemes, plantation projects and unknown deposits. Their focus is on the return. Therefore, safety in their lexicon is the return of principal invested . To transition to becoming investors , they should know that what happens to their money depends not on the promise, or who made the promise, or how it was packaged. It depends critically on how the money would be put to use. Focusing on who will hold the money and manage it exposes the investor to the risk in deploying the money. To invest is to understand that there would be risks in letting someone else use our money , and the quality of the promise depends on who that is, and what they do with our money, and how well regulated their activity is. Investors seek information . They understand that no promise can hold unchanged into the unknown future. They like to check the quality of the promises made to them, and act on it. To transition from saving to investing , is to come to terms with risk and get armed to deal with it, rather than hope for risk to go away.

Third, savers fail to work out the math in finance. Since their focus is on preservation than growth, they are not sensitive to the fact that every rupee can earn interest every day. They do not seek the efficiency of putting their money to work, and abet lazy money lying undeployed. Allowing money to lie in bank accounts is quite common among savers. Investors seek efficient use of capital. They understand that not all investments need to be for the long term. They seek cashlike options such as liquid funds to ensure that their money is deployed and earns a decent level of return. Savers overstate the complexity in investing, and decide that unless they know which the next best investment option is going to be, they may not be able to make an investment decision. To invest is to understand that it makes perfect sense to earn an average return at lower risk, by investing in a range of assets, than try to figure the next best thing.

Fourth, savers are lured by bargains. They like the idea that a rupee saved is a rupee earned. They also feel a sense of importance and accomplishment when they have made financial decisions that result in immediate, visible savings. Buyers of insurance products do not see it as a decision that involves regular outgo of premium over years for risk protection and a poor rate of return. They only see the immediate tax saving that is possible. They also like the benevolent seller who compels them to save some money regularly. Young earners buying large homes so they compulsorily save and build an asset, which will grow in value, fall in the same category. They fail to see that they may need liquid assets in early stages of their lives. To transition from saving to investing, they need to see that assets come with varying combinations of return, risk, liquidity and desired holding period. The choice of a product needs to consider immediate as well as future needs. After saving tax for three to five years, several default on insurance policies, unable to set aside the huge premium, thereby losing an investment opportunity.

Fifth, savers think there should be a prim and proper way of doing things and if they have to become investors: someone should lead them to making the right decisions so that they are protected and guided correctly. As it is in life, so it is in investing. The shades of grey in investing are something they should learn to deal with. Savers kick and scream about being led astray and their expectations from service providers tend to be unrealistic .

Investors see that they have to make informed choices, and be responsible for their actions. They are prepared to do the hard work, when they make their investment choices.

Have you made your transition yet?

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