“Naïve” means “inexperienced” in particular tasks assigned, even while taking important decisions of investments.
There are instances in pasts wherein, investors use ‘naïve’ rules of thumb for portfolio construction due to lack of better information.
One such rule is known as the ‘1/n’ approach, where investors allocate equally to the range of available asset classes or funds (‘n’ stands for the number of options available).
This approach ignores the specific risk-return characteristics of the investments and the relationships between them.
Example
Mr Arun Kumar working with MNC company received annual performance bonus of Rs 2 lakhs which he want to invest for wealth creation.
He made a plan to invest equally in Top 5 large Cap Funds, Top 5 mid Cap Funds, Top 5 Debt Funds and Top 5 Balanced Funds. So, post investing his portfolio will have 20 mutual fund schemes. He had the option of investing in debt and equity schemes with different objectives from various fund houses.
Here, he took a naïve decision of investing equally to the range of top performing funds thinking its diversification in his portfolio. But, he ignored the risk-return characteristics and it was random investment approach for wealth creation in the longer term.
This strategy may result in diminished performance in the portfolio; but it may increase the risk exposure of an investor’s portfolio depending upon the risk level of each investment option.
Thinking Man advice ways on becoming sophisticated investor instead of naïve investors as follows:
- Adopt a simple investment approach which you understand and can follow rigorously to build a diversify portfolio.
- Connect with a financial advisor to ensure a balance of risk and return from investment portfolios.
