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  • Writer's pictureAkshay Nayak

Defensive Investing Decoded - II : What It Takes, And Why It Works

In last week's post Defensive Investing Decoded - I : Conceptual Framework, we understood how defensive investing works. We also understood the concepts underlying the approach. Continuing the discussion today, we will see what it takes to be a successful defensive investor. We will also understand why the defensive approach would work well for most investors.

Being a successful defensive investor has a lot to do with developing the right mindset. Anyone who follows the defensive approach does not view investing as a return centric exercise. They view it as a result centric exercise. In other words, a defensive investor aims to achieve the right results from their portfolio. This implies having enough money available to meet their goals whenever they fall due. They do this without exposing themselves to an unduly high degree of risk. The rate of return at which they achieve the required amounts does not matter as much to them. So any aspiring defensive investor must learn to look at portfolio performance and effectiveness more holistically. Returns from the portfolio must not be their sole focus and objective.

Successful defensive investors also appreciate the benefits of a simple portfolio. They therefore use a limited number of simple products that are transparent and easy to understand. Finally they understand the importance of diversifying portfolios adequately at low costs. They therefore use products that offer broad based exposure to an asset class at low costs. Aspiring defensive investors must appreciate that simplicity, low costs and diversification are the drivers of successful defensive investing.

We can now look at why the defensive approach to investing would work well for most retail investors. Retail investors usually focus on picking the 'best' products, speculating about market events and predicting market trends. This would put most investors in the enterprising category. Success as an enterprising investor would require considerable amounts of time, knowledge and effort from the investor. It would require them to build the best performing portfolios over the next 20-30 years in the present. Most retail investors therefore cannot meet the demands of the enterprising approach.

An apparent solution to this would be to hire professionals to employ the enterprising approach on the investor's behalf. But the services of most professionals would come at a significant cost. Most professionals would charge a percentage of the value of the investor’s portfolio fees. And even then, most professionals fail to deliver the kind of superior returns they promise. All this ultimately does is to significantly eat into the investor’s returns.

Success as an enterprising investor is therefore hard to achieve. And it is even harder to sustain.

Success as a defensive investor simply requires two things. These being :

1. Knowledge of a few fundamental concepts of personal finance (covered in last week's post)

2. Adherence to a few principles of product selection and portfolio construction

With adequate education and behavioural coaching, most investors can certainly achieve this. Dynamic management of the asset allocation or products in the portfolio would not be required. This implies that the defensive approach demands a lot less time and effort from the investor. Therefore a defensive investor's chances of achieving sustained success are a lot higher.

The defensive approach is easy to understand and follow. Tangible success in any aspect of life is born from discipline and consistency of effort over a period of time. Simplicity of approach promotes discipline and consistency. And because the defensive approach is simple, following it automatically increases our chances of sustained investment success.

The raw material for any investment portfolio is an income that grows consistently. Greater income would invariably translate into an ability to save and invest more. This automatically increases our chances of being able to meet our periodic investment targets for our goals. This enhances our prospects of ultimately meeting our financial goals.

The defensive approach does not require much time and effort on the investor's part. This allows them to focus on professional growth and maximising their earning potential. It reduces dependence on return from the portfolio. It also allows investors to wholeheartedly pursue their other interests in life.

All of this points towards a single overriding conclusion. Very few investors have the right mental wiring and psychological orientation to be successful enterprising investors. The majority of the investor community would benefit from displaying the humility to acknowledge this fact. And once that is done, the natural course of action would be to opt for and adhere to the defensive approach. In next week's post I will show how portfolios can be built with an orientation to the defensive approach.

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