Place of stock in personal portfolio

Most people debate whether they want to be a passive investor or active investor, but I have a more fundamental question: is stock market just a hobby or an economically viable investment avenue for the common man?

Indian stock market is clearly not a passive investment tool. The quantum of money that can be made by timing the market right (even blue chip or Sensex/Nifty) exceeds the returns made by a 1-3 year buy & hold strategy/monthly SIP in a diversified portfolio (not speculative penny stocks). Hence it is not surprising that most investors and part-time traders spend at least 5 hours a week in reading financial news, analyzing the results/analyst reports or even exchanging tips. Even the mutual funds (passive investors) are profitable when the individual is able to time the market and pick the right sector/type of fund.

So let me rephrase the original question and add 2 dimensions to it:

Firstly, most (sane) humans work 40-50 hours a week. Sacrificing an additional 5 hours a leisure time for stock market will be economical only if I can derive 10% of my salary from stock market (in addition to the cost of capital).

Let me elucidate:

Assume your salary is 10Lakhs and you have 15Lakhs invested in the stock market. This portfolio will be economically viable ONLY IF you are able to generate: 2.5Lakhs annually as stock market profit (1 Lakh for the 5 hours/week, and 1.5Lakhs for the lost interest rate & risk premium (CAPM)).

To be really professional, you should also apportion cost of your TV, internet & newspaper subscription.

The second dimension is on the size of the stock market portfolio:

If the asset allocation <10% then my base is too low to improve my financial situation. (i.e. even if I achieve a fabulous 100% return in the stock market, my net-worth would only marginally improve by 10%)

How many seasoned investors have you met, whose stock market exposure is more than their exposure in real-estate or gold or business (as sleeping partner)? Esp. if you consider that this Diwali stock market reached its all-time high. “If I believe that money attracts money” then most people would have not only ploughed back their profits into their portfolio, but also allocated a major chunk of the savings.

For me a hobby is an economically non-profitable pursuit undertaken as part of the leisure time available. And somehow, I have not met many *part-time* stock market investors/speculators/traders who earn economic profits.  If stock market is unable to compensate me for the time devoted or is the transformational lever that will enable me to retire rich… then it’s just a hobby.

PS: Please read this humorous dialogue elaborating that not many common men made money.

Bonds Part IV: Bond duration 5 years vs 10 years vs 15 years

Under most circumstances the farther is the maturity date, higher is the interest rate one receives on the bonds. However often one does not have such a long investment horizon. In that case should one forego the extra interest in order to match the term date or should one go for the extra interest and hope that he/she would be able to sell the bond off at a profit?

1. If you believe that the interest rate would fall in the future, then go for the longer duration bonds. This way you can capture the maximum value.
2. If you believe that there will not be sufficient liquidity on your bonds or the credit rating of the issuer might deteriorate over time then go for the right duration only (in fact I might even go for a shorter duration)
3. If you are not into trading and know when you would need your money back then this simple calculation can be of use.

Eg: IFCI was the last firm to issue bonds. It offered 2 options 10.5% on a 10 year bond and 10.75% on a 15 year bond. For simplicity let me assume that it is a cumulative bond.

So a 15 year bond would mature at 46,255/- (10,000/- face value)

While a 10 year bond would mature at 27,141/-. So by keeping the money for 5 additional years, you can multiply your money by (46/27) = 1.7 times. 11.25% interest (compounded annually) for the remainder 5 years. (Similar computations can be done for coupon bearing bonds but it would require some excel work)

I know in this example I am fiddling with the 8th wonder of the world (Power of Financial Compounding), but you get the gist. One might think that an extra 25 basis points might not be too big an enticement to lock oneself into a 15 year term. However if you do an incremental analysis, that 25 basis points become 75 basis points. This is something worth considering. Also it would provide certain protection in case the interest rates go up. (however remember you are not completely hedged, and can incur a loss if the interest rate goes up too much)

What is more interesting is that in case of bonds with put option, longer duration bonds tend to have a different put schedule. So if the interest rates goes down substantially then the put option would be exercised later hence giving you a chance to make the most of the situation.

Gist: If the interest rates stay the same/move downwards, then its best to go for a longer duration bond (provided it has liquidity) else try to match the duration with your investment cycle.