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Do you know which Ponzi scheme you are a part of?

Investing your money has just got more complicated. Thanks to the dramatic drop in inflation, interest rates are barrelling downwards. The stock market has rebounded this week, but it's not worth betting your life's savings on it. It doesn't know whether it is going or coming.

Real estate is a no-hoper in the short term. Everybody's betting on gold, so it just might rise. But don't count on it as investment; it is insurance.

If inflation falls below zero, even money under the pillow may look like a good investment as it can buy more stuff. But it's risky; your maid servant may discover it before you do.

We are at that point in time where all investment theories are failing simultaneously. The momentum theory --where you keep investing in assets that are rising in value -- works only in a bull market. The diversification theory - spreading your investments over several avenues - isn't working for now because most assets are in decline. The SIP theory -- investing steady amounts every month through bull or bear markets -- is fine if you believe that over the long term shares (or equity mutual funds) will beat other forms of investing.

But how long is long? Five years? Ten years? In the 10 years from 1992 to 2002, you would have made more money from bank fixed deposits than shares despite two intervening bull markets. Stock returns are largely a matter of mass hysteria, not reality. You can make money as long as belief in the long-term is widespread and enduring.
Then there is the asset allocation theory. Put your money in a mix of equity and debt, and keep shifting money from assets that are rising to those that are yielding lower returns currently. If equity is rising, sell some of it and invest in debt. Or vice-versa.
While this strategy rebalances risk periodically, it is not necessarily a route to higher returns.

For example, if you had invested in equity and debt in a 50:50 proportion in 2003, and kept shifting money from shares to FDs and bonds at regular intervals, till as late at mid-2008, your returns would have been lower than if you had the left the money alone. I am not saying that asset allocation and rebalancing does not work; but it is about reducing risk, not improving returns.

The main reason all theories fail at some point or the other is the unpredictability of human behaviour.

The theories presume something about human responses to external stimuli, but herd behaviour cannot be predicted. And your returns depend substantially on how other investors are thinking.

Let me repeat: your returns depend not only on what you do, but what others do. If you buy Infosys, your returns will, of course, depend on how the company fares; but you will make big money only if other investors are piling in after you. If they don't buy, you don't gain. In short, the early investor's gains come from the arrival of later investors. This is the reason Robert Shiller, author of Irrational Exuberance , calls the stock market a "naturally occurring Ponzi scheme."

The Ponzi analogy applies not just to shares, but to all asset classes. If you had bought property in 2003, before the gold rush began, you are sitting pretty. The guys who bought houses in late 2007 and 2008 are suckers, late entrants to the real estate Ponzi scheme. They are busy defaulting on loans.

The Ponzi principle applies --- but less rigorously --- even to safe investments like bank fixed deposits. If deposits are growing faster than loans, the later you join in, the lower your interest rate. If you had opened an FD in November or early December, ou could have locked in to 11% interest.

Now rates are down to 8-8.5%. As more investors get in, banks are cutting rates as fast as they can without frightening politicians in an election year.

In short, no matter which investment avenue you choose, your returns depend on how the crowd behaves. Your returns are lower if you join the herd later. Broadly speaking, the Ponzi principle works like this: The early bird gets the worm. The later ones get worms.

The moral: All investing is Ponzi. So invest in the Ponzi that is closest to your heart and wait for the herd to get in. At some point, they all do. Don't depend on high-fangled theories to deliver returns.

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