Probability Blindness

Me and my friend were having a conversation. He said he has allocated his sip money to three funds belonging to different market-cap categories. I said great, how did you choose them? He used some past track record and some indicators to pick them.

After hearing to him, I told him its better he put some money in index funds and a small portion in the fund managers he was bullish on. Over time once he is more confident he could increase is allocation to the successful ones slowly but less amounts maintaining a healthy balance.

Obviously he was not interested.

Now, I can tell you its very very improbable that you will be able to choose a fund manager who would be successful over the next 10 or so years of your major investment period. Most of us are very easily fooled by past data. If picking a future successful fund manager based on past track record was so easy historians would be super rich. Once you are chasing a fund manager you want him to be able to successfully outperform a market index with less risk over a long term horizon. If you are basing your decision on past track record, do a study, go back 20 years, take the best 50 funds on any criteria for first 10 years and see how many still successfully seated the market in next 10 years? There will be very few its the nature of stock market or for say any market. You can stress test it using various statistical techniques however the answer remains same.

When you are putting your entire sip money with three self-chosen (discretionary) fund managers you are over-confident in your ability to choose the person. So what to do never give any money to a mutual fund manager or a person? No I never say that. But it should be small portion of your equity investment capital not a huge one. For example, out of 100 sip amount 60-80 should be in an index fund while rest you can consider your risk capital for other fund managers. This is a more risk sensible way while putting all money in your ability to choose people.

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