Saturday, November 15, 2008

Make money when the markets fall

The stock market is an ideal avenue to make money in the long run, provided the money is invested in appropriate equities. At the same time, the markets can be destroyers of wealth in the short run, as many people would have experienced by now. There are few stories on how people have created wealth and held onto it through stock market investments. However, there are an equal number (or more) of stories about how people have lost their shirts and even had to go to the extent of committing suicide. This is not how equity investing is meant to be.

Most people only think of equity when the going is good and tend to ditch equity as fast as Ranbir Kapoor’s character dumps his girlfriends in the movie “Bachna Ae Haseeno”. This problem is witnessed more across the so called sophisticated Institutional and Ultra High Networth investors. However, just as solid relationships are the foundation of a good life, so are good quality stocks the foundation of an investment portfolio. And sticking around and building the portfolio when the markets fall delivers stellar returns over the long term. Equity returns are a function of the price that you pay for investments. Your investment returns are determined by the price that you have paid on a particular date.

Just like it’s easy to time the real estate market, it’s extremely difficult to time the equity markets, with the daily swings. In just 7 trading sessions the markets have the potential to go up or down by 40 per cent. So, buying at the lowest point might not be possible, however buying lower certainly is.

Instead of looking at this as a wonderful opportunity to buy, the same investors who were confident of making 15-20 per cent in just 2-3 weeks from equities have suddenly developed cold feet now. The logic is - I will jump in when the market bounces back. The market, however, is in no mood to tell anyone when the reversal will actually happen. Investors who sell out in bear markets tend to make their losses permanent. However, in reality all you have done is 'Sell Low and then Buy High' later, which is the exact opposite of what should be actually done.

Hanging on to fundamentally sound equity investments and infact buying more when the markets stink may sound stupid when lots of sophisticated investors are packing off and investment gurus are sounding off bearish tones. But these are precisely the times to make the best returns and in bearish times, even history has been on the side of bullish investors. Markets could take a few years to recover and there might not be anything to write home about in your equity portfolio as of now but the cheap prices that you will pay for good equity investments will compound tremendously in the next 10,15 and 20 years.

Most people buy gold and real estate and do not check the prices every day. A similar strategy of not looking at the prices or 'Buy it, Shut It and Forget It' can also go a long way for stocks. However, you should certainly review your asset allocation and every investment regularly to see whether the fundamentals of the investment still hold. But there is no point in checking the prices every day and then worrying about what it will do in the next 2 weeks.

Investors who resisted the urge to sell back in 1992, 2000, 2004 and 2006 have made stellar returns on their investments after the markets have bounced back. However, people might not like to wait for 2 years, but when you actually sell in this market, you never recover.

Just as an example, in 2006 when the index was at 9300 levels, Bharti was quoting at Rs 325. Today, even though Sensex is at 9700 levels, Bharti is still trading at Rs 600 plus. This shows that though index levels are the same, you would have still made money if you had held on to that stock. Returns are not a function of index levels but a function of valuations and the price that one pays for an investment. The strategy to adopt in such markets is to regularly invest and make one time contributions when markets overreact and correct sharply on the downside.

The cardinal rule to learn from this example and from several seasoned investors who have made money in equity markets is that “Emotions should not drive or should not be your investment strategy”.
- Amar Pandit

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