Seven Steps to Happy Investment

( This is one of the best advice I have received - R. J. C)
By Dhirendra Kumar

Once again, Indian investors are in a manic-depressive mood. They undergo bouts of wild joy when they see where the markets are heading and how the value of their investments has increased. At the same time, they are sick with worry about whether they should stay invested and whether they should invest more.The stock markets have reached higher than they have ever done before. This is a good thing for investors but is also a dangerous one. Remember, more bad investment decisions are made when the markets are at a high than at any other time. All-time highs may be exciting, but all savvy investors know that at times like these one's thoughts should be on what not to do rather than on what to do.We know it's difficult to control one's excitement, but this is the right time to get back to basics and reaffirm one's knowledge and faith in the basics of investing. Here are some simple rules and principles that will ensure that you can prevent yourself from making the worse mistakes that the stratospheric heights of the stock markets can induce.
1. It isn't different this time, not reallyEvery bull run brings out the chronic optimist in investors. This time, we feel, things have changed fundamentally and the markets will go on rising up for a long time. Sure, we feel, they may pause a bit, but surely they won't fall ever again. Every great bull run that the Indian markets have seen in living memory has come complete with a set of reasons 'proving' why it was different this time.In 1992-1993, we were told that liberalisation had fundamentally changed India and the markets were transitioning to a totally different level and the old rules no longer applied. A couple of years later, during the IPO-inspired boom, investors felt that the abolition of capital controls had resulted in money flowing into the markets on a new scale that would change the rules of the game forever. In the tech boom that got going in 1999, we were convinced that information technology and the Internet would forever change the rules of doing business and investing.In 2004, we were being told that India's hour of global competitiveness has arrived and that henceforth, old assumptions and rules about the value of Indian business do not apply.On each one of these occasions (except 2004), there was eventually a painful reminder that the rules had not really changed and if the markets' rise and eventual fall were demonstrations to this effect. Interestingly, none of the basic premises on which these bull runs were justified were really wrong. Liberalisation did transform the Indian economy, as did vigorous public participation in IPOs. The IT industry's crucial role in the Indian economy is unchallengeable, as is the new global confidence of Indian businesses and economy.In each case, the problem lay not in the basic cause but in the euphoria generated by the it's-different-this-time propaganda.
2. Bulls are no substitute for knowledge & understandingAs the stock markets rise, most people appear to need fewer and fewer justifications for investing. A couple of years ago, when the markets were down in the dumps, hardly anyone would make an investment without putting it under a magnifying glass.When the markets started rising, the focus seems to have shifted to what one may call faith-based investing. Investors have faith in the general talk of how the markets will keep on rising and therefore find almost any investment worth making, regardless of how little they know about it. The feeling is that the markets will go on rising and therefore all stocks are worth investing in.This zero-knowledge investing is a recipe for disaster. Since investors get into a stock or a sector without knowing why they are there, they cannot figure out when to get out and even how to figure out whether its time to get out.The rash of sector funds that have been launched lately means that even fund investors-who would normally be immune to ignorant investing-are prone to investing without understanding. Fund investors with perfectly well-balanced portfolios are going around putting money in sector funds without figuring out their own pre-existing exposure to those sectors.Our advise is simple--do not invest in stocks, sectors and funds that you do not understand. And if you do not have the time or the inclination to understand anything specific, stick to a handful of mainstream diversified and balanced funds.
3. You can't have it all'Buy low, sell high', goes the oldest mantra of the markets. Yet investors do their returns much damage by trying to 'Buy lowest, sell highest'. No matter how much you try, it isn't possible to time the markets with a reasonable degree of accuracy. If you insist on waiting to realise all possible gains by selling at the very highest point, you are likely to miss it altogether.If you want to make money with a reasonable certainty, don't mind leaving some of it at the top of a price peak. If you've made reasonable gains, get out without agonising over unmade gains--you won't lose anything.
4. It doesn't matter whether the Sensex makes senseOne question that most financial media is obsessing over is whether fundamentals justify the levels to which the markets have risen? Clearly, the answer to a question like this is expected to have a certain predictive value. Implicit in the very act of asking such a question is the idea that if the markets' level is justifiable, then it will be sustainable and if it is not justifiable, then this level will not be sustainable. This is something that we do not believe in. Therefore, if we observe that the fundamentals justify current market levels, by no stretch of the imagination can that be construed as saying that the Sensex is going to go up to X,000 level (for your choice of X) or even stay at the current 9,000 level. Markets rise and fall for many reasons and fundamentals are only one of those. They are perfectly capable of dropping way below levels that are justified by fundamentals.Fears that the market levels may not be justified by the fundamentals are based on the fact that the BSE Sensex is at its all time high. Historically, the stock markets have always fallen rather sharply soon after registering such levels. While this is numerically true, increasing profits and thus falling valuations make a 9,000 today a very different thing compared to peak levels that the index has recorded in the past.In February 2000, when the tech-inspired bull-run was about to be stopped cold by the Ketan Parekh scam, the weighted average P/E ratio of the Sensex companies was around 26. At the time, the Sensex was at 5,924 points. In January 2004, when the Sensex reached its all-time high, its weighted average P/E was around 20. Now, the P/E is around 17.But P/E ratios, and those too only of the Sensex, are hardly the whole story. There are many other factors that point to a solid base for the current market levels. In contrast to 2000, today's market is incredibly broad-based. Then, it was the technology sector (fuelled partly by the dotcom hysteria), that was skewing the averages upwards. Today, there are happy stories across most industries including some very unlikely ones. Most importantly, there is no longer any doubt about the global competitiveness of Indian companies.It goes without saying that there are many clouds on the horizon. Oil prices, the slow-motion collapse of the US Dollar, rising inflation and interest rates could all dampen things. Of course, 'the fundamentals of the market' are a bit of a red herring. As every investor (and even some day traders) know, there is no such thing as the fundamentals of the market. Sure, we have seen averages of the valuations of the companies that make up the indices and they do paint a happy picture but these are measures whose use is mostly to decorate newspaper articles and Powerpoint slides. To real investors, even the index is of only marginal interest and what matters are only the numbers behind the stocks they are holding. The average P/E of the Sensex is thus of very little comfort to someone who has a portfolio full of HLL stock.The worst danger of high stock prices is not in the prices themselves but in the irrational optimism that they start engendering after a point. Just about any market level is fine as long as investors keep a cool head and don't think of investing only when the market is rising.
5. Beware of the hype machineAll financial media: the pink newspapers, the business channels on TV and the business magazines see their business improve when the markets go up.Now, we at Value Research try to be an exception but the fact is the entire financial media is a massive hype machine that is predisposed to being optimistic. Good news sells, bad news doesn't. For example, major business channels and pink newspapers go into wild celebrations every time the Sensex crosses a round figure like 5,000 or 6,000. The newspapers have giant decorated headlines and the business channels have breathless newsreaders screaming at the top of their voice.The media does all this because its good business but it does create an atmosphere of frenzy that drives people to invest NOW! The feeling that if one will miss a lifetime's opportunity by not investing immediately takes over and that leads to bad investing decisions.Investors need to guard against getting too involved by the media hype. We are not asking you to stop watching TV or reading newspapers but try and concentrate on movies, music, cricket and other useful things in the media-reading or viewing a news story about the Sensex does nothing for you as an investor.
6. Value mattersWhen the markets are rising, its easy to forget about whether the stocks you are getting into are good value at the price you are paying. There are plenty of good stocks that are just too overpriced at a point like this.As someone observed recently, brokers appear to be hawking many more buys when the Sensex is at 9,000 than when it was at 5,000. This doesn't sound like rational investing. Surely, if one is evaluating a bunch of companies as potential investments, there would at least be some that would be worth investing at lower prices but not at current ones.It doesn't sound likely that the number of worthwhile investments would actually rise when the markets rise, yet if one is to look at the 'research' that is being churned out, there are more 'buys' now than earlier. Clearly, researchers and investors have stopped looking at whether some investments are justifiable at current prices.
7. Did you do it, or did the market?One of the strangest things that happen in a broad rally is how every investor gets convinced that it is his genius that is delivering gains and not the market. We have a situation where almost every stock and fund is rising sharply. Over the last couple of years, practically all that has been necessary to get good returns is to just invest.In this situation, there is a temptation for investors to look at their portfolio, see how everything is gaining and convince themselves of their own investing genius. As a bull-run goes on, this emotion keeps getting stronger at an ever-faster rate. By the time the markets reach a seriously high point, there is a large mass of investors who have fully convinced themselves that they are invincible. Convinced that whatever they touch will turn to gold, they start going around touching things randomly.If the rally still has some steam left, this seems to work for a while. Typically, investors with this attitude go around looking for stocks that have not yet risen but are 'about to rise'. Late in a rally, these are, almost by definition, dud stocks. If the rally continues and someone is actively plugging a stock then this seems to work for a while. Eventually, either the stock or the rally runs out of steam and the investor is left holding a stock that has fallen disastrously. Some such stocks may actually be worth nothing since they are too illiquid to sell.In a strong bull-run, investors must keep both feet on the ground by continuously comparing the investing performance of their entire portfolio (and not just one or two stocks) with some external benchmark. This will keep things in perspective.


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