Yesterday I received a mail from one of a blog reader requesting me to review his equity portfolio. He started investing from February 2016. All his investments are in DIRECT Funds. This motivated me to write the post.
Before proceeding further, I want to make sure that I am not against DIRECT MUTUAL FUNDS or DIY (Do It Yourself) theory.
I want to link few of these direct mutual fund investors or DIY theory followers to Dunning-Kruger effect. Because these few investors are exactly doing of what it is said Dunning-Kruger effect. Let us know what this effect is.
Dunning-Kruger effect is a cognitive bias theory where unskilled persons suffer from illusory superiority. They try to mistake in assessing their ability. This is one part of this effect. This I purely relate to a DIRECT Mutual Fund Investor.
Further, this theory suggests that highly skilled individuals may underestimate the relative competence and may wrongly assume that the tasks, which are easy for them, are also easy for OTHERS. This I purely relate to a few who are EXPERT but assuming others can also do it easily by investing in DIRECT mutual funds.
The miscalibration of an investor about his ability is an error about SELF. However, the miscalibration of an expert is about others. Investors’ miscalibration is natural, he looks for an expert advice, and he simply follows. However, the danger is when an expert advice so easily that others can also be followed by what he is following. It sometimes leads to a disaster.
This Dunning-Kruger effect was inspired by a study, which is explained in Wikipedia as “McArthur Wheeler, a man who robbed two banks after covering his face with lemon juice in the mistaken belief that, because lemon juice is usable as invisible ink, it would prevent his face from being recorded on surveillance cameras.”
Dunning and Kruger proposed that, for a given skill, incompetent people will do as follows-
- Fail to recognize their own lack of skills-This means you don’t have the skill of understanding how mutual fund investments work or how to identify the right funds. However, you act like an expert and invest in DIRECT Mutual Funds.
- Fail to recognize their extent of inadequacy- They don’t know what they are doing. They don’t the repercussions of such blind act. However, they ACT.
- Fail to recognize genuine skill in others-Investors just follow few experts who preach DIRECT funds or promoter of DIY theory. However, fail to understand that they suite to it or not.
- Recognize their own lack of skill after exposing-They realize their lack of knowledge only after the act turned to be a disaster.
Why I linked this theory to this above-mentioned new investor?
Because I felt and I firmly believe that the above reader of whom I mentioned above decided to invest in mutual funds on his own. Saving penny of a commission was in his mind. However, he don’t know of what he is doing and where he is heading. Suddenly, after the investments, he felt uneasy due to negative returns in his portfolio.
Within a month of equity investments, he is turning to be so over-reacting means how can he be long-term investor. Choosing online platform is the best for all gadget savvy investors. I completely support that. However, failing to know of what they are doing or acting with overconfidence leads to danger.
Mr.A may be experts in managing his own money. He may preach to all. However, investors must think about whether they are capable like Mr.A to act, monitor, be patience or adjusted for volatility. I feel it a herd mentality. If one preaches direct funds or DIY theory and he is expert means following blindly of him. If he is investing in XYZ fund means I too invest. If he possesses negative view about ABC fund means I too must have same view. I may say madness at its peak.
At the same time, I am not at all against Direct Mutual Funds or DIY theory. I always suggest my clients or readers to take control of their money today or tomorrow. This is the only solution in this financial world. Because at the end of the day it is your money, you know the risk, you know your goals, you know how much important each rupee is. But not the expert or your fellow friend who is investing in direct funds or following DIY theory.
First, understand your limitations. If you are capable of handling your portfolio, then I will suggest of going for DIRECT or follow DIY theory. Otherwise, simply take an advice of adviser whom you believe can handhold you in long run. Remember the point here that finding a right adviser is also the toughest task on this earth. Be cautious, test his each suggestion, cross-question each recommendation, and finally invest after better understanding. This is the only solution to invest and learn your money properly.
We don’t know when we need money. We don’t know our financial goals. But eager to invest in Mutual Funds. I often face the questions like “I am interested to invest in mutual fund for the period of 5-10 years. Hence, recommend me some BEST funds”. Sadly, they don’t know that 5-10 years is a big gap of 5 years. Investing for 5 years has been different than investing for 10 years. Understand yourself first is a first step of investment. Rest of the calculation, choosing products monitoring will come into picture at a later stage.
Again, I am finally repeating and stressing, if you are capable then go for DIRECT or DIY theory. Otherwise, a big NO.