Friday, 15 July 2016

Stock Investing Should Be Simple, Not Simplistic

An analyst on a business-news channel was saying this with gleaming eyes and feeling as proud as a peacock: “This housing-finance stock is just going to go up because the demand for new houses is just going to increase with time. This company is a direct beneficiary of the Indian government’s focus on housing for all.” Another bright chap I know bet on an FMCG company because he thought its products would never be out of demand. Yet another person justified his “long-term-investing” mindset saying that the Indian economy is only going to expand, so forget about everything and stay invested.

Most analysts and investors receive heavy doses of the tonic called “Keep It Simple.” It is said that the simpler the investment argument is, the better it becomes. And we all know many investors who have made huge money by just keeping it simple. The problem with being simple is that simple arguments frequently turn into “simplistic” ones.

What’s the difference? Something that’s simple solves complexity and something that’s simplistic disregards complexity. Getting to simple isn’t simple. Those who get to real simplicity are the ones who have dealt with complexity and know how to steer their way through it—just like driving. Driving isn’t simple for someone who is not trained in it. But a skillful driver makes things look so easy and effortless. If an amateur driver looks at a trained driver and thinks that driving is all about moving the steering wheel correctly, you know what fate he is destined to meet.

The simplistic arguments mentioned at the beginning overlook several important aspects. For instance, the first two arguments undermine the impact of competition and the last one overlooks history altogether.

How to get to “simple” then? Devote yourself to the trade in question and experiment. The trial-and-error method is the best way to unravel the puzzle. As you spend more time on something, you will naturally cut through complexity and arrive at simplicity. And those who unwittingly stick to the simplistic will only find that the path to their failure has just got simpler.

Friday, 1 July 2016

Don’t Get Mad about Positive Portfolio Returns

The other day a colleague of mine who has recently started investing directly in stocks asked me if it’s okay to sell out the “losers” in his portfolio so that the aggregate portfolio value looks better. Obviously, I asked him not to. On another occasion, an amateur analyst, who has just acquired an MBA degree, advised me to buy “puts” for my portfolio so that I can hedge it against market downturns. I scratched my head for some time, trying to understand the logic behind his argument, and eventually decided to junk the idea.

Obsession with positive portfolio returns isn’t just an obsession with the analyst community; laypeople are equally affected by it. A positive portfolio return is taken as a barometer of your prudence in stock selection. Those who have poor aggregate returns tend to slip into self-inflicted inferiority complex. They should not.

There are quite a few problems with the obsession with positive portfolio returns. Since you are almost never going to sell the entire portfolio, aggregate returns mean little. Secondly, if you sell out your profitable positions, the portfolio sinks into red, which may artificially make it look ugly. Sometimes it’s because two or three stocks that the aggregate portfolio looks bad, while the others are doing pretty well. That doesn’t mean that you get desperate to sell out the nonperformers. Selling out should always be dictated by your stock strategy and not market movements.

Doing all sorts of acrobatics, such as buying puts, to “save” your portfolio is no sign of investment savvy. On the contrary, I consider it a strong indicator of muddled thinking. Your “savior” strategy can soon turn into a booby trap, and you will be looking for another savior to save you from the first. Complex products, like calls and puts, are not only difficult to understand; they are also difficult to manage.

The best thing you can do when your portfolio goes into negative is do nothing. Fall in stock prices is a fundamental aspect of the stock market, and you must accustom yourself to tolerate it quietly. Eventually, if you are invested in good stocks, you will find them regaining their lost heights. As to the amateur analyst with his pristine MBA degree, God save him from himself.