Exercising with consistency is important for a healthy lifestyle. Let’s say you decide that you need to lose weight to achieve the goal of a fit lifestyle. Your weapon of choice is running. You get yourself some fancy running shoes, running gear, a tracking device etc. You even enrol yourself into some fitness program under a qualified trainer to guide you. The fitness goal also demands you to develop new habits like eating on time and letting go of a few like eating a high carb diet etc. Day by day you track your weight loss and burnt calories via your tracking devices and continue to do it regularly. At the end of the year, you notice that you have achieved your desired weight category. The fitness goal demanded consistency, patience, self-control, discipline and you aced it.
Investing is similar to that. To achieve financial goals, the investment journey requires continuity, patience and a long-term vision. To successfully create wealth guidance of a qualified, experienced investment advisor; possibly SEBI registered (fitness trainer) is also necessary. An investor has to invest continuously and track regularly, to see if the portfolio fulfils financial targets. Investing demands inculcating few habits like savings and letting go of a few like overspending. A person cannot hit bull’s eye if he has no clue where the dartboard is and by how many inches, he missed it. Investment plans with targets, tracking and periodic rebalancing help in wealth creation (hitting bull’s eye). Every portfolio is rebalanced so that changing market scenarios do not hurt CAGR. Optimization is the goal.
When an investor talks about optimizing CAGR he means getting a good return on investment over time. Everyone wants more money in the end. For a period of 10 years, a 5% CAGR generates 63% return, 10% CAGR generates 159% return, 15% CAGR creates 305% returns and a 20% CAGR gets you 519% returns! Hence, it’s very important that investor tracks CAGR on the entire portfolio.
There are numerous rational and logical ways to maximize a CAGR on investment (so many that it deserves a separate blog).
But other than rational ways to optimize CAGR (persistence, patience, time etc.), behavioural biases have to be kept in check too. An investor loses money not because the market timing is poor, but because he can’t exercise self-control or emotions cloud his judgement. (He either held on to losers for long or sold the winners too fast. Why? Attached sentiments with stocks are one of the many reasons).
Let’s say a person invested ₹10,00,000 in 10 different stocks that make up his portfolio. While he is tracking the performance of his portfolio, he notices that few stocks outperformed, few underperformed, few are steady. He either becomes overexcited and focuses only on outperforming stocks or is too disappointed over ones that didn’t. Such behaviour only attracts trouble as emotions cloud judgement and slow down decisions. Instead of grieving or celebrating an investor needs to check if loser stocks need to go or winner stocks need to be bought on board. Also, the emotional rollercoaster hinders the investor from noticing if the fluctuations in the stock market maximized his overall portfolio CAGR/IRR (did the Rs. 10,00,000 become Rs. 23,00,000 or Rs. 8,00,000?).
As an investor, it’s OK to make a few wrong decisions on the choice of stocks as every wrong choice is a lesson for life. Any investor invests in a portfolio in the first place so that market fluctuations (or poor choice) do not harm investment prospects. Had an investor approached his portfolio rationally, the odds of him optimizing CAGR are very likely. He will accept his poor choice of stocks gracefully and rebalance by cutting losers loose in no time.
Because at the end how much you made through the entire portfolio is far more important than a part of your investment performing good or bad.