Wednesday , 24 October 2018
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Big brother’s permission for equity investments

By Tensing Rodrigues*

If SEBI has its way, you may soon require a permission from the ‘big brother’ to invest in equity. The purpose is to prevent individuals from reckless investment in equity, viz.  protecting investors against their own greed. SEBI believes that many investors invest in equity without understanding the nature of risk in equity investment and their own capacity to bear that risk.

What it plans is to make it mandatory that the assets of the investor be certified by a chartered accountant and/or by a broker who will decide up to what extent an investor can invest in equity. Essentially certify the capacity of the investor to bear the risk of equity investment. In other words, the CA/broker will certify that this individual will not be in financial distress if she loses money in her equity investment. The SEBI is trying to bring in something like the concept of ‘accredited investors’ that prevails in many developed markets. In some countries the criterion is education of the investor.

This is a rather dicey issue. At the first sight it looks like curtailing the freedom of the small investor to invest where she wants. At the same time we know that the small investor has often made a fool of herself by treading into territory she knows little about and is not sufficiently equipped for. I would compare it to trying to climb the Everest without knowing anything about the Himalayas and without proper mountaineering gear. But a bigger question is: Can a person be protected against herself?

What drives a small investor into this big game hunting is flawed logic.  If X can do it, why not I? Forgetting that X is a veteran hunter and has hounds for protection. Does that mean that a small investor should not invest in equity? That would be unfair and unwise. Every investor big or small should have the opportunity to gain from equity. But she should not be in a hurry. First she should begin with somebody holding her hand. That is, begin by investing in equity mutual funds. But that cannot take away the whole risk. The basic risk of equity will always remain. What investing in equity MFs can achieve, is to protect the investor from making uninformed decisions. To that extent her risk will be reduced.

The worst mistake that a small investor can make is to tread into the dangerous territory of margin trading and derivatives. In both the cases the initial amount required to take a position is relatively small. So the investor fails to realize how big risk she is taking. But if the gamble fails, the investor needs to cough up sums which can be beyond her capacity. That is when the financial distress comes; and her position becomes that of Draupadi in the game that the Pandavas played.

It is however important to know that there is a safe investment in equity. If one picks up shares of a company, not with the purpose of making a fast buck, but to own a slice of the profits that the company is making, then the risk in equity investment is extremely low. But such an investment requires that one makes a choice prudently and holds to it for long. Such an investment does not require a big financial capacity, but definitely requires much home-work.

What is equally important is to take baby steps – to invest in small amounts. Rather than absolute quantity of rupees, this has to be understood in terms of the total wealth available to the investor. The thumb rule is simple. If the amount invested in equity is fully lost, will it cause financial distress to the investor ? If yes, do not invest. If no, go ahead and invest. Investment in equity – whether directly in shares or in equity MFs – has always to come from your surplus which you can afford to lose. That is the prawn which you put for the hook of your fishing line – if you succeed, you get big fish; if not the prawn is gone. Do not put for the hook the prawn which is meant for your lunch !

So, SEBI’s mandate or not, this is the due diligence that every investor needs to do. The catch in the situation, and which the SEBI seems to be overlooking, is that this applies not just to equity but also to bonds, and the so called debt funds. What can remain outside the ambit of the ‘risk profiling’ are the contractual investments like bank deposits.

* The author is an investment consultant. Readers can send their comments and queries to investment.ideas.shop@gmail.com

 

 

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