Active and Passive Demat Accounts

Have Two Demat a/c’s for Passive, Active Investments

by VIVEK KARWA, CPFA., CFPCM, Financial Chronicle 22/12/2011

source: http://www.mydigitalfc.com/personal-finance/have-two-demat-acs-passive-active-investments-552

We all hear it often and know very well that long-term investment in stock markets has the best possible chance to deliver better returns when compared with most other investment products. This theory is then supported by throwing up the names of a few most successful investors in the world. If in case, we ask these investors to repeat their performance, how many can actually do it is a big question in itself. There is no intent to question their success here, but times have changed and the way information flows has changed too. Earlier, an Indian investor may not have been bothered about rest of the world and even if he were bothered, the flow of news would not be as rapid as today. We often hear about stalwarts not having a system on their desk, but, can the same strategy be adopted today?

Instant information: These days we are bombarded with information, although, much of it may be unwanted. We are in the age of television, SMSes and micro-blogging sites, like Twitter, which keep us just few seconds away from news in any part of the world. All news affect stock prices and the latest trend is the increasing number of issues cropping up on the corporate governance side. Don’t you think managements were more honest 10 years ago, than they are today? Considering these points, one can be certain that the markets are much more volatile than earlier times and would remain much more volatile over the coming years.

Instead of considering volatility as an investor’s enemy, we must accept it as the norm of the day and use it in the best interests of our portfolio. It is this volatility that is helping long-term investors buy stocks cheap and the same volatility is attracting more investors to trading. There is no single investment strategy that can be considered as the best bet, and, hence, every strategy would have its own advantages and disadvantages, or else making money would have been much simpler.

Market volatility: Volatility is attracting even long-term investors to engage in trading, which is not a good sign. The major problem, here, is that most investors invest in the markets not knowing why they are actually investing. Consider this: A person may have been investing regularly in the market and may have built up a fund, but, if today, he requires some money, say to buy a car, he most probably would withdraw the savings and start spending regularly towards running costs. Had this investor’s financial planner attached a goal to this particular savings by saying, “This investment is for your child’s education”, the very same investor would have thought a hundred times before dipping into this fund due to the sentimental reasons attached to it, which is his kid’s education!

So it is neither wrong nor right if one wants to invest and trade as well in the market. Controlling oneself from trading has become difficult for investors these days, and most investors whom we meet, lack patience, which is the most critical part in investing. We often tell our investors, “in markets, if you don’t be patient you would soon become a patient”, and, frankly, these words often fall on deaf ears. As said earlier, there is no fixed “best strategy”, and, hence, any strategy, which can earn profits for an investor, can be considered.

Investment strategies: The most common strategies, which most investors are also aware of, are: First, passive investment strategy, and the second, an active investment strategy. Investors, who neither are pure long-term players nor pure traders, can divide their portfolio into two within a demat account. Or, if having self-control within one demat account is not possible, one may go for two demat accounts also. Hence, one could be a passive account and the other could be an active account.

In a passive investment strategy, one tries not to time the market. Timing the market is one thing that every investor likes to give a shot at, but knowing well that timing is not possible, investors still attempt it! Some people mistake their few success stories in timing as their skill. This account can be termed a “core portfolio”.

In an active investment strategy, one tries to move along with the market, and, hence, may shift from cash to assets and vice-versa, quickly depending upon the market direction and headwinds. It is a dynamic portfolio, which moves along with the market just like how a satellite moves along with the earth, and, hence, can be named a “satellite portfolio”.

Investments in the core portfolio should have a long-term vision. Each investment will be linked to a specific goal in life, and, hence, would try to invest in safer stocks, better managed mutual funds, tax-efficient investment products and debt instruments, after considering the risk profile of the investor and the time duration of each of his goals in life. The core portfolio will have a lower churning ratio, and, hence, would also be cost effective for the investor. An asset would enter a core portfolio after full understanding of the reason and the fundamentals. An investor can exit the portfolio if the goal has been achieved or the fundamentals on which it was bought itself have changed. Hence, there may be total withdrawal of the asset if the goal is achieved, or, the asset valuations warrant a sale, or, the asset may be liquidated in order to introduce a new one in the portfolio.

After asset allocation has been done towards each life goals in the core portfolio, the investor can invest the balance funds in the satellite portfolio. A satellite portfolio is more aggressive and churns the assets actively as per the market sentiments in order to generate a bigger alpha. A satellite portfolio, thus, offers the opportunity to quickly take advantage of short-term price movements, and, thus, is near-term focused, unlike a core portfolio. An investor may wish to try all his trading skills in a satellite portfolio, hence, clearly demarking the safer investments from riskier bets. If the satellite portfolio is, indeed, able to deliver better returns, then, the overall investment returns on the investor’s funds — core + satellite — would help him create that extra cash flow, which many of us look forward to.

Even in case all the strategies in the satellite portfolio go wrong, and losses have to be suffered, the investor need not panic because the goals are already secure in the core portfolio. This strategy shall work in all type of market scenarios if followed diligently. It is a human being who has to finally fix the rules.

(Vivek Karwa is a CFPCM. The views expressed here are personal,and do not necessarily represent that of the organisation. FPSB India is the sole marks licensing authority for the CFPCM marks in India)

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One thought on “Active and Passive Demat Accounts

  1. Neatly written and a solution has been offered who are in a fix – long term or short term !
    have been maintaining a core portfolio

    Like

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