NEVER forget that what goes up, must come down.
This rule, I believe is the cornerstone of a successful and contented life. A sudden rise in the stock indices may have you smiling from ear to ear. It’s the slide that tests your real strength.
And if the current slide makes you feel timid, wealth gives you these six tips.
1. Hear no evil
Forget about rationalizing and explaining (or listening to other people explain) why stocks are falling. It’s a pointless exercise.
2. Remember the bad times
File the experience away as a worthwhile reminder of how risky the stocks are. Draw on that memory during the next market boom when optimistic market seers tell you that stocks are not risky.
3. Don’t wait it out
If you believe, based on your preferred market measure, that stocks have over corrected, don’t wait for the correction to end. In my case, I was investing in 1997 through 2008 — it had nothing to do with the equity markets. It was a conviction that long-term monies should be in equities. So, if I have long-term money, it goes into equity, other wise it goes into a money market mutual fund.
4. Be contrarian
Recognize that even if you are right about the market overcompensating for past mistakes, there will be months of pain before the gain. Being a contrarian is easy on paper but much tougher in practice.
5. Change of perspective
Markets will go up and go down — you cannot change that. You can change the way you look at it. When you have money you will invest, when you need money you will sell. There is no call to action based on ‘what the market will do’. So that does not matter.
6. Get real!
Console yourself with the recognition that the professional portfolio managers and the market experts you see on television are staring into tele-prompters not crystal balls.
These tips should keep you afloat even if things go from bad to worse. And when they do, here is another rule for you to remember : No Matter How Bad things are, remember they can always get worse! And on that happy note, I shall bid you goodbye
How to avoid the mistakes of 2006 in 2007?
Yet another fabulous year for the Indian Stock markets comes to an end. Though the year has been the most volatile of the last 3 years, 2006 has several records to its credit namely the 5 different index levels of 10000, 11000, 12000, 13000 and the recent 14000-Watt Kiss. Despite the rollercoaster ups and downs like the ones in Disneyland, the Sensex and Nifty have delivered handsome returns of 43.35% and 36.47% respectively.
As we usher in the New Year, it is time to understand the mistakes of 2006 some of which tend to be perennial and try no to repeat the same in 2007 for our long-term financial well being.
1. Looking at the Stock Market for making quick bucks just because your neighbour or friend has.
Just because the Sensex has delivered 32% returns in the last 5 years and some of the best funds in excess of 60% does not mean that future returns will be similar. Don’t just focus on the last 5 years but also look at the last 10, 15, or 25 years of performance across various timeframes. Try to understand the realities of the stock markets and you will figure out whether there is any mismatch between your expectations and what the equity markets can deliver.
Contrary to popular belief, stocks are long-term wealth creation instruments. But, most of the people use them as short term instruments to make quick bucks and when the tide turns against them, they swear never to look at equities again. Some people religiously follow each and every piece of investment wisdom available through TV, print media and believe activity is the name of the game. Investing in the stock markets on the contrary is not a game or a contest; it is a continuous process over one’s lifetime.
2. Leveraging or Borrowing to Invest
“Borrow at 13% for 1 month and invest in IPOs, or tips. I made 50% by dabbling in futures in 2 weeks. My wife earns Rs. 10000 every month by trading her account and she has just put in Rs. 3 lakh, rest is margin money provided by the broker ” were some common talks heard in 2006. Because of the tantalizing returns, it is very difficult to control your sanity levels and one might be considered guilty of committing a Sin of not using exotic derivatives or leveraging your portfolio or borrowing to invest. Some people learnt the hard way that using leverage can get you to lose more than 100%, IPOs can list down 40% on Day One and a lot of IPOs of 2006 are still way below their offer price. 2007 might or might not see some sharp corrections but the probability of intermediate corrections is on the higher side. So for your peace of mind and prosperity, do not leverage or borrow to invest. Understand the risks associated with it and only bite what you can chew and digest comfortably.
3. Believing Nonsense
I often come across ads which state, “Invest only Rs. 50000 and earn Rs. 5 Lakh, Intra Future Short Term Tips” to tips such as “Ye Stock 3 Months main Double hone wala hai”. In bull markets you will come across plenty of such nonsense, which you can comfortably ignore. On the institutional side, everyone from insurance companies, banks, brokers (commodity, equity), art funds to mutual fund houses have been coming up with a deluge of offerings with everyone eyeing for a share of your wallet. Recently I came across a ridiculous ad from SBI Mutual Fund stating “Best of all the 4 regions working for you”. Though this fund house has some of the best performing schemes of the last 3 years, it is shocking to see schemes being packaged and marketed like FMCG products. This is unlikely to go down in 2007 with several insurance, asset management companies / mutual funds, private banks waiting to make a big bang entry into the country. So ignore the noise.
4. Timing the Markets
Timing the markets is one elusive strategy yet millions of people aim to do it and many claim to have done it. Whether it’s the technical analysis or the fundamental analysis or a combination of both, getting your entry and exit right is the most difficult to achieve. This has been amply demonstrated to people who tried to do this in 2006 and will again be proved in 2007. Market ups and downs happen in very short spurts of time and we have seen in 2006 that even a 1000-point fall is likely in a day or so. There is no man or woman in the history of investing who has been able to do this consistently day in and day out and I doubt whether going forward there will be anyone who can achieve this impossible feat.
The difference between investing at the highest and lowest levels of the Sensex every year from 1979-2004 is only 1.8%. So don’t fret whether you are investing at the highest level or lowest level, just do it systematically every year.
5. Overconfidence or Pessimism
Everyone likes to talk about their success but very few people like to talk about failures or even admit them. Overconfidence and pessimism are two sides of the same coin. First four months of 2006 saw a lot of overconfidence only to be followed by many months of pessimism. 2007 is likely to witness similar emotions depending on whether the index goes upwards, downwards or stays between a narrow range.
A person I knew during the technology boom believed that he had the Midas touch that most of his fellow equity investors of this country did not. He used to track and trade on every market move and boast of his winners but never talk of his losers. The longer he kept at it, the more overconfident he grew. That’s because obsession over the market made him believe in his ability to spot future winners. He made increasingly aggressive bets, which sooner or later were bound to explode and this is exactly what happened. He later on became so pessimistic that he stayed out of the market even during the upturn from 3000 to 10000 only to enter in at 11000.
The stock market will make even the most adventurous person humble and you would excel in investing by understanding this reality.
Action Items for evading mistakes:
a. Make a New Year resolution to first and foremost spend some time thinking about your future goals and writing them down on paper. Writing your goals on paper have the power of making them a reality. Or best yet Read the book “ Think and Grow Rich” by Napolean Hill…Yes you read it right, the key is to think because we live in a world of m TDO “Thinking DEFICIT ORDER” and Thinking would certainly take you one step closer to rationality which is an important ingredient in the world of investing.
b. Keep yourself level headed in 2007 and have reasonable expectations. The key is to exercise self-control, and you can get this to work for you simply by understanding yourself a little better. Socrates said “Know thyself is the key to Human advancement” and this statement takes the cake for its relevance and importance to how we understand ourselves think and act when it comes to equity investments.
c. Do a Financial Fitness Checkup by looking at your overall asset allocation, products, time horizon, return objectives and risk tolerance.
d. Finally Prepare an Investment Policy that will form the basis for your buy and sell decisions. The purpose of a written plan or a policy is to help you prevent costly mistakes, help you achieve your goals in life , providing comforts during very stressful moments while at the same time enjoying your journey called life.
Most people spend more time planning their vacations, deciding which car or plasma TV to buy, than planning their finances. It is beyond comprehension why people behave in this fashion yet this is one of the important areas that will determine your overall financial net worth. An article published in Fortune Magazine in 1999 described a study that found investors who made written plans by the time they were 40 wound up on an average with five times as much money by age 65 as against those who didn’t have written plans.
Keep an eye on the mistakes outlined above and ensure that you profit from them. A wise man said, “The best time to buy stocks was Yesterday. The second best time is NOW. View corrections in the market as great buying opportunities and do not miss some of the ones you will get in 2007.
How to make hay when the market crashes
Most people have entered panic mode. Retail investors are hurling abuses at FIIs, the finance minister, P Chidambaram, the Securities and Exchange Board of India (SEBI)and everyone else who has caused panvati (curse) to the markets.
Those who are long on futures and holding call options, have had their wealth wiped out, instantly. But it is important to understand that we have a similar scenario every time there is a correction.
I always warn people that the markets can be very lethal if you enter without proper knowledge. But powered with knowledge, market corrections and falls are a great opportunity to create wealth.
You can rise in the fall!
A 1,400-point fall at the Sensex scares away speculative buyers and in turn makes things a lot cheaper. Many stocks today are being offered at discounted prices compared to their earlier highs.
Many of them still continue to have growing profits and in some cases even improved fundamentals. Some of the world’s richest investors have used market corrections and pessimism to buy cheap, and create their millions and billions in the long term.
Warren Buffet loves buying when others are pessimistic. Remember, people who create wealth do things that others don’t. When everyone panics and sells quality stocks, you can accumulate them at a lesser price. If you have a long-term perspective of at least one or two years you will create a lot of wealth.
So, what do you do?
Ignore those people who are busy spreading doomsday theories. Look back and you will see how the market keeps making a new high after every correction. Always keep some cash handy to make the most of these times.
No matter what the levels of the markets, undervalued companies will always exist. In fact, a few undervalued companies I have invested in, have become even cheaper now. This makes it all the more appealing for me to buy more.
Sos, make the most of such situations and I assure you, you will create a lot of wealth.
Why some investors quit the market
Imagine this: you bought Reliance Petroleum (RPL) shares at Rs 280 thinking it would climb to Rs 300.
Instead it falls to Rs 210. So, you sell the shares thinking it will further fall to Rs 180. But the next day it shoots up to Rs 220.
Now, in such a situation if you had played in ‘futures’, it would have caused enough damage to your portfolio. Futures are basically contracts, which state that you can buy (or sell) the share at a future date, at an agreed price.
Unfortunately, several retail investors have fallen into the futures trap, due to which they made huge losses so large that they end up quitting the stock market completely.
Even today, I get e-mails from retail investors who share their experience of being caught on the wrong side of the futures game. What would be worse: looking at the Sensex at 30,000, two years later with the share price of RPL at Rs 500!
The downside of futures
I know of many small futures traders who lost a huge amount of money when the markets corrected sharply in May 2006. A few of them even went bankrupt and decided to leave the markets. Had these people not traded and just invested in a few good companies they would be much richer today.
Trading in futures has a downside to it. For example, if you have invested Rs 100 in futures, your loss would be much more than Rs 100 if the markets don’t go the way you want them to. Several retail investors play in futures simply on the basis of tips provided by their broker.
This is not the best way to trade and according to me it’s a gamble. In the short term, stock prices tend to be very volatile and unpredictable. Several times they move in either direction without any logical explanation.
A single announcement by the government is sufficient enough for the stock market to tumble down by 700 points. This makes trading almost suicidal. F&O Details
What drives the futures game
One of the main factors why so many people play in futures: greed.
I agree that trading in futures is tempting. I used to trade in futures too, but stopped after making losses. I am glad I made those losses; I learnt from them. Lucky for me, they were not too huge.
The main reason I made losses: I did not spend enough time learning how futures work. I did not invest in knowledge.
Experience has taught me that long-term investment is quite profitable. It may not make you rich overnight. But it also will not make you bankrupt overnight.
Don’t try to make short-term gains by investing in futures. And if you want to invest in futures, do it after you have complete knowledge
It will allow you to sleep peacefully at night rather than worrying what is happening to world markets and how much more losses your futures will incur.
Flout investment rules, at your own risk
Every human being has fallen down several times before learning to walk. Every rose has a thorn and every medical practitioner has to see blood. All this is part of system, one cannot a them.
Similarly, inflation, taxes, government policies, geo-political situations and economic cycles affect all investments.
These risks exist in system. There is no way one can a them. Inflation will reduce the real rate of return from all forms of investment, may it be debt or equity or property. Similarly, taxes eat into the final returns in the hand of investor. In a communist economy wealth, creation is difficult, irrespective of risk taking ability of an individual. Likewise, if local currency is revalued all forms of investments will get impacted. Risk that exists in system is called “SYSTEMATIC RISK.”
There is absolutely no way to a systematic risk. However, by adopting time averaging (popularly known as Rupee Cost Averaging or Systematic Investment Plan) one can reduce the impact of systematic risk. Impact of risk is averaged out by investing fixed amount at fixed interval. Since more investment units will be bought at lower cost and less investment units at higher cost, over a prolonged period, averaging will start working in investors favor. Please note investment could be in any class of asset. It could be in debt, equity, or property. Another strategy, which is superior to time averaging, is value averaging. However due to it’s complexity it is usually not only recommended.
Another category of risk is “Unsystematic Risk.” Risk which does not exist in system as a whole but which is specific to a particular asset class or particular investment product is called unsystematic risk. Other name for unsystematic risk is specific risk.
Crashing of property prices in mill area of Mumbai due to unfavorable court judgment is called unsystematic risk. Similarly, if CEO of Wipro Ltd resigns causing stock a price to tumble than it is called unsystematic risk. Another example could be of crashing of gold prices due to government control.
Diversification is best solution for controlling unsystematic risk. Diversification has different meaning to different investors. There are some who invest in six different floating rate schemes of mutual funds and feel they have diversified. Others feel that by investing in different stocks they have diversified e.g. their portfolio will consists of HLL Ltd., Marico Industries Ltd., Gillette India Ltd and P&G Ltd. A closer look will tell you that all are FMCG stocks. Yet, there are few who diversify through different investment vehicles e.g. They would have mutual fund schemes which invest in equity, ULIP which invest in equity and would also have rendered services of portfolio manager for their equities.
Diversification means investing in asset classes which has negative correlation. In nonprofessional’s language, it means that when performance of one asset class goes up, other asset class falls down. This will ensure that overall portfolio returns remain stable. If the explanation has to be further diluted, it would state that do not place all your eggs in one basket. By diversifying the portfolio, unsystematic risk is significantly reduced.
There can never ever be risk free return. Risk free return does not exist. In fact, return is solely a factor of risk. However, proper understanding of risk will assist in generating higher returns with same amount of risk
The balancing act part I: Risk vs Return
As an investor your objective is simple – ‘Maximise return and minimise risk’. The first part of the equation, the return, is relatively easy to understand. It is objective in nature, in as much as, when you undertake an investment, you have a fairly good idea as to what the return is going to be. It is quantifiable, it is a number.
However, what about risk? How do you quantify it? How do you minimise it? How do you achieve the fine balance required between risk and return to optimise your investment consistent with your goals?
Well, let us begin with understanding the concept of risk and its various facets.
Systematic Risk, as the name suggests is the risk inherent in the economic system. Macro factors such as domestic as well as international policies, employment rate, the rate and momentum of inflation and general level of consumer confidence etc. are what constitute systematic risk. Generally, investors cannot hedge or diversify against this risk as it affects all kinds of asset classes and affects the entire economy as such.
This is the risk inherent in a particular asset class. The best way to combat this risk is by diversification. However, one must remember that the diversification must be in the class of asset and not the asset itself. An example of the above is evenly distributing your portfolio in bank deposits, Reserve Bank of India (RBI) bonds, real estate and equities. That way if a certain unsystematic risk affects let’s say the real estate market (say the prices crashes), then the presence of other classes of assets in your portfolio saves you from a total washout. However, note that diversifying within the same asset class (buying different equity shares) is not strictly combating unsystematic risk.
Understanding Unsystematic Risk
The one thing that almost all investors would agree upon is the fact that equity is definitely more risky than debt. Irrational exuberance with a rising market has left many an investor losing their shirts and in some cases even more sensitive garments.
However, does this mean that investing in debt instruments is entirely risk-free? Unfortunately, the answer is in the negative though the volatility is much less. So first, let us examine what kind of risks do debt instruments pose
Interest Rate Risk
Interest rates and prices of fixed income instruments share an inverse relationship. In other words, when the overall interest rates in the economy rise, the prices of fixed income earning instruments fall and vice versa. Interest rates in the economy may fluctuate due to several factors such as a change in the RBI’s monetary policy, Cash Reserve Ratio (CRR) requirements, forex reserves, the level of the fiscal deficit and the consequent inflation outlook etc. Extraneous factors such as energy price fluctuations, commodity demand and supply and even capital flows may result in rates fluctuating.
Then there are the event-based factors that affect interest rates. For example, the 11/9 episode in the United States of America and 13/12 in India. If there is a war, interest rates will rise. However, typically such events are temporary in nature and in fact a good fund manager can actually take advantage of such hiccups.
To illustrate how fluctuations in interest rates affect the returns, let us take the example of mutual funds (MFs). Adjusting the portfolio to the market rate of returns is called ‘marking to market’.
We assume that the current Net Asset Value (NAV) of the MF is Rs. 10 and its corpus is Rs. 1000 crores. This means that if the fund sells all the assets of the scheme and distributes the money on equitable basis to all the unit holders, they will receive Rs. 10 per unit. Now suppose, the interest rate falls from 10% to 9%. Immediately, thereafter you wish to invest Rs. 1 lakh in the scheme. Realise that the entire corpus of the fund stands invested at an average return of 10%. If the fund sells the units to you at it’s current NAV of Rs. 10, you will be allotted 10,000 units. This will benefit you immensely. You will be a partner in sharing the benefit of the higher returns of 10%, though the fund will be forced to invest your Rs. 1 lakh at the lower rate of 9%.
This is injustice to the existing investors. Therefore, something has got to be done to protect their interest. Here comes the ‘mark to market’ concept. The fund raises its NAV to Rs. 11.11. You will be allotted only 9,000 units and not 10,000. The returns on 9,000 units at 10% would be identical with the returns on 10,000 units at 9%. In other words, the NAV rises when the interest falls
This is the risk of default. What if the company whose fixed deposit you invested in goes bankrupt? There have already been several such cases. Deposits with plantation companies and time-share resorts are more cases in point. True, you have legal remedy…but everyone knows how much time our courts take.
The only factor, which dilutes this risk somewhat is the credit rating. Fixed income earning instruments get rated for varying degrees of safety. Investing in a highly rated instrument is safe but not sufficient. Firstly, the instrument may be down graded, you have to be on the lookout for the same. Then there have been cases where the issuer has got rated by different agencies but chooses to indicate only the higher ones.
Elimination of Risks
There is some good news though. Credit risk can be simply eliminated by investing in sovereign securities –securities issued by the government. There is simply no risk of default. Or so we hope, for retail investors, MFs offer gilt schemes, where almost the entire corpus is invested in sovereign securities thereby achieving the same result.
Interest rate risk discussed earlier is always prevalent. However, it comes into play only when a transaction is undertaken during the pendancy of the fixed income instrument. Ergo, it follows that if the investment is held till maturity, there would be no interest rate risk.Investments such as Public Provdent Fund (PPF), Relief Bonds etc. are normally held till maturity. These are examples where both the risks inherent in debt instruments are at a bare minimum
Government Action Risk
This is a unique kind of risk, which has reared its ugly head in recent times. In the previous paragraph, it is mentioned that the interest rate risk is eliminated by simply holding the instrument till maturity.
However, such principles of investment had not contended with unilateral governmental action. For example, the rates of PPF over the past three years have been consistently reduced by the authorities from 12% p.a. to 8% p.a. To add insult to injury these rates are applicable on the entire corpus and not on additional investment. Relief Bonds have come down to 8%. Rates on other small saving instruments have also been slashed across the board. Unfortunately, there is no escape from this risk — that of our government!
So far, we have acquainted ourselves with the kinds of risks inherent in investment instruments. However, merely knowing this much may not be enough to take an informed decision. The article began with the premise that return is objective since it is quantifiable. Then, can we not try and quantify risk?
Well, age old statistical tools like standard deviation and regression help us do precisely that. Next time we shall touch upon these basics of Modern Portfolio Theory, which enable you as an investor to actually quantify the risk existing in the investment you are contemplating.
When the stock market crashes
THE last three to four years have proved to be a roller coaster ride for the stock market.
The Sensex doubled from a level of 3000 on May 3, 2003, to 6000 in January 2004. When the Bharatiya Janata Party lost the elections in May 2004, the market plummeted to 4500 (a 25 per cent drop in just four to five months).
But within six months, the market recovered and again, the Sensex touched 6000 before the end of 2004. Thereafter it was almost a one-way journey right up to May 2006, when the market hit the 12,000 mark.
Later, the market saw a sharp correction when it dipped to 9000 level in June 2006. But pretty soon, it crossed the 21,000 mark by January 2008.
Since then, we have witnessed some pretty sharp falls. And the fact that it doesn’t seem to be bottoming out, is making investors a lot more nervous. Of course, volatility is not something new. But the sharp ups and downs are scaring even the old-timers who are in this business.
First, cut out all the noise and clutter around you and get back to basics. This is because 90 per cent of the people around you are as clueless as you are. So, when you let the facts speak for themselves, you have a better chance of eliminating ambiguities. Let’s find out what these are.
Fact 1: The equity market is NOT a lottery ticket. Every share has a fundamental value and is based on the company’s performance
Fact 2: It is possible for share prices to be widely different from their intrinsic value.
Fact 3: In the long run, share prices always move towards their true value depending on the profitability and growth potential of the company.
Fact 4: Irrespective of whether the United States goes into recession or the sub-prime problem generates more losses, India’s economic growth rate will still be comparatively high.
Fact 5: Unless we have some serious calamity, a political crisis or poor monetary or fiscal policy, we may continue to see over 7 to 7.5 per cent growth rates over the next 5 to10 years.
Fact 6: If the economy continues to grow at such a healthy rate, it has to reflect in the corporate performance as well. This will lead to appreciation of the share price sooner or later.
Keeping these facts in mind, the long-term outlook for India still remains quite positive.
- 1. Do not panic.
- 2. If you have invested in good companies and mutual funds, stick to these choices.
- 3. It’s a good time to invest in the market.
- 4. Be patient and disciplined. You will be rewarded