Catching the falling knife
An extreme case is an investor with a single stock portfolio. He has been betting on the wrong horse and increasing his stake. The stock that he has been accumulating – Unitech – has been consistently falling due to structural problems. But ignoring the deteriorating fundamentals, he kept on accumulating the stock – a classic case of catching the falling knife. To accumulate an increasing volume of the stock he sold the other stocks in his portfolio. Now he holds 10 lakh shares of the company at an average cost of Rs 4 a share. The present market rate is Rs 1.40. Even now he is confident that the share would rise to Rs 8 and he will make a profit of Rs 40 lakh. I asked him, “ why didn’t you buy HDFC Bank, HDFC, TCS, Infosys, ICICI, ITC, HUL, RIL, L&T….? His answer was simple: “they are all very expensive, and therefore, risky.”
Biting more than what one can chew
Another case is an investor who has too large a portfolio. He didn’t know how many stocks he had in his portfolio. I counted; it was 135. A retail investor can have a portfolio of, ideally, 25 to 30 stocks, certainly not more than 40. The larger the number of stocks in the portfolio, the more difficult it would be to monitor the stocks.135 stocks in the portfolio would make it impossible to manage. Many stocks in this 135 stock-portfolio were bought on tips. His investment in low-quality stocks was huge and in bluechips was very low. He had lost much more money in small-caps than he had made in quality large-caps.
Selecting the wrong fund
My discerning readers might now be thinking that these guys should be investing through the mutual fund route rather than through equity directly. But wait a minute: mutual fund investment also can go wrong if the investment is made in the wrong product. Which takes me to the third case of an investor who had invested Rs 25000 in an infrastructure fund in 2008 and recently redeemed it with zero appreciation. Investing the entire investible amount in a thematic fund was her mistake.
The solution to these follies is simple. Successful investment in stocks requires expertise and time. Those who have both can do that. Large-caps are always safe. Low-grade stocks should be avoided like the plague. Those who don’t have time and expertise should invest through mutual funds. Thematic funds should be avoided unless there is a compelling case for that. Investment in small-caps should be done, ideally, through mutual fund SIPs. Investors should have a clear idea of their financial goals and risk appetite. Asset allocation should be done based on that.
The following facts/ideas will help investors get the art of investing in proper perspective, help avoid some usual mistakes and facilitate rational decision-making.
- Stocks give the best returns and beat all other asset classes in the long run. This is the lesson from the history of investment of the last 150 years.
- Quality stocks give good returns in the form of dividend; they give excellent capital appreciation; they are liquid, i.e. they can be converted into cash quickly; they are safe and they give good tax benefits.
- Capital appreciation can be incredible in the long run. Investment of Rs 9500 in 100 shares of Infosys (IPO) in 1993 is now worth around Rs 7.2 crores. The opposite also is true. If the investment were made in poor quality companies, the investor would have lost a major part of his investment, sometimes, his entire investment.
- In India, stocks have given excellent returns in the last 40 years. The Mumbai stock index Sensex, which was 100 in 1979, is now (March 2019) around 38000. This means, the original investment made in 1979 has multiplied 380 times during the last 40 years. This works out to an average annual return of around 16 %.
- The most important factor determining stock market returns in the long run is corporate earnings growth, which in turn, depends on the economic growth rate. There is a global consensus now that India has the best potential to achieve the highest growth rate in the world in the coming years. India has overtaken China to become the fastest growing large economy in the world.
- To understand the benefits from stock investing we should know the power of compounding. Investment of Rs 1000 every month for 30 years will grow to Rs 10 lakhs at 6% return, Rs 22 lakhs at 10 % return and Rs 70 lakhs at 15 % return. This is due to the ‘power of compounding’, what Einstein called ‘the 8th wonder of the world’.
- Investment in stocks is highly tax-efficient. Dividends are exempt from tax upto Rs 10 lakhs. If the stock is held for more than a year, the capital gains are exempt from tax upto Rs 1 lakh a year. These tax benefits make stocks an excellent asset class.
- To get superior returns from the stock market: start investing early, invest regularly, invest for the long term and invest intelligently.
- An essential principle of investing is: Don’t put all your eggs in one basket. Therefore, an investor should spread her investment among asset classes like bank deposits, PO Savings deposits, gold, real estate and stocks. A part of the investible funds should be invested in stocks for superior returns.
- Asset allocation should be based on the investors’ financial goals and risk appetite, i.e. how much risk the investor can take. This depends on the investor’s age, income levels, expenditure commitments etc. Age is the most important factor. The ideal investment strategy should be to invest more in stocks/ mutual funds (risky in the short run; but not in the long run) in the early phase of one’s career and less in stocks/ mutual funds and more in fixed income like bank deposits while approaching retirement.
- To get superior returns from investment, invest in good quality stocks. Assess the quality of the stock from the track record of the company.
- The quality of management and the nature of the industry are important factors.
- Investing in stocks is like starting a business. When you buy shares of a company, you are buying ownership in the company. You own a business without the headaches of running the business. A great bargain!
- You need only average skills to invest in the stock market. A popular adage in the stock market is: “To be successful in the stock market, you need only an average person’s intelligence; but ten persons’ patience.” This is true. To make money, buy stocks of good quality companies and wait with patience.
- Investors who don’t have the expertise or time to invest in stocks directly may invest through mutual funds, preferably through SIPs.
- Even if your philosophy is to buy and hold for the long term, continue to monitor your stocks and consider selling them if they’re not appreciating or if the market conditions have turned bad.
- Keeping informed every day about your portfolio, the financial markets, and the general economy will help you manage your investment better.
- Keep a tight control on your debt and finances. In turn, this practice will ease the pressure to invest aggressively with a short-term focus and help you focus more on the longer term instead.
- Don’t buy a share touching an all time low. Don’t sell a share continuously scaling all time highs. ‘Exit from the weaklings’ and ‘Ride the winners.’
- Panic and greed are the two extreme emotions in the stock market. Blinded by greed some traders make reckless bets. Some investors panic and flee from the market when the market corrects. Don’t succumb to these extreme emotions.
- Most great investors are contrarians. They buy when the crowd sell and they sell when the crowd buy aggressively and irrationally. Warren Buffet famously said, “Panic when others are greedy; be greedy when others panic.”
- Don’t succumb to the temptation of buying cheap stocks. Good things are not cheap; cheap things are not good. This rule is applicable to stocks also. Good stocks are always expensive.
- If you feel that the market is likely to move up, but you are not sure which stock to buy, buy the index. When the index moves up, you gain.
- Don’t average a crashing stock. It would be like trying to catch a falling knife.
- Disciplined, systematic investment in good companies run by proven management is sure to reap rich rewards. Good stock selection, systematic investment and patience will work wonders.
- Big fortune is made not by ‘working for money’ but by making ‘money work for you.’ When you make a good investment you are making money work for you. Remember that wealth is not earned; it is created.
- Don’t try to time your investment. Any time is good time, if you have patience and you are investing in good stocks. More important than timing the market is the time you spend in the market, that is, patiently waiting for good returns.
Happy investing!