If you had to name one muddled science, stock investing would qualify for it instantly. There are as many theories and methods of investing as there are analysts, investors, traders and experts. Interestingly, the search for the holy grail of stock investing is still on. Investors, analysts and experts are still looking for that one foolproof way which can help them make money in all seasons. Sometimes they look at Buffett (or any other star investor); sometimes they look at data; sometimes they introspect; but the quest for one perfect method doesn’t seem to be getting over.
This quest has given birth to several formulas and rules that have become so entrenched in investing that they almost look sacrosanct. For instance, consider the division of stocks by their size: large, mid and small caps. Somebody sometime divided stocks by size. This thought then penetrated so deeply in investing that you have separate strategies to deal with these stock types. Many investors like to divide their portfolios across them. The thought itself has become the foundation stone of new theories and methods.
Now the moment you decide to have some sort of allocation, you commit yourself to investing in only that type of stock, no matter if there are better, more sound opportunities available elsewhere. In your "small-cap portfolio," you can’t buy a large cap or a mid cap, even if you have an opportunity available there. The same is true for "style-specific" portfolios. If you have a "value" portfolio, you would probably overlook "growth" or "dividend" or other opportunities.
In stock investing, and for that matter in other areas of life as well, we often tie ourselves up with rules, formulas, methods and ideologies. They look convenient at the time of formation, provide clarity and familiarity, and make the complex world simpler, but at the same time they take away freedom of thought. Once you have adhered to a method for years, it starts to look like an eternal truth that you can’t refute.
So, should you have no methods? We all need them to make sense of the world and progress with our daily lives, including investing. But we should not be a slave to them. We should be willing to evaluate them from time to time. If something else sounds better, we should give it a try. We should also try to hone our existing methods and beliefs to make them fit the times we are in. All this is an interesting process if we show openness to it.
As far as stock investing is concerned, try to make your method as open as possible so that you aren’t tied to some belief. All you need to do to succeed in stock investing is to find good companies and stay invested in them. Rest everything is optional.
If you buy a stock, what do you have to pay? The most obvious answer is the stock price plus the brokerage and taxes. That’s true but that’s not the total cost. The total cost of investing in a stock or the stock market is its quantifiable element and the unquantifiable element. When most investors talk about costs, they are talking about just the quantifiable element, not the latter one.
What is this unquantifiable element? It is the peace of mind. By investing in the stock market, you unknowingly commit to parting with your peace of mind. Now there are many things apart from stocks that can deprive you of the peace of mind and we are not going to talk about those lest we would enter into a philosophical realm from which it is difficult to escape. But like those things, stocks also can also claim a fair share of the peace of your mind. Ironically, most investors invest in stocks for wealth creation that could give them peace of mind eventually, but that’s what they keep losing every day.
How does this happen? No matter if you are an experienced investor or a rookie, movement in stock prices causes you to experience a range of emotions over a short period of time—from ecstasy to despondence to anxiety to fear to doubt to irritation and so on. These emotions and their rapid fluctuations and recurrence are as if you were on an emotional roller coaster for the full day. You can imagine the impact it has on you. Little surprise, people in the financial industry age faster (my own observation; I don’t have any study backing it).
Emotional instability is the biggest cost you pay for investing in stocks. And because this cost can’t be stated in a currency, investors keep paying it without knowing that they are. This cost is much more than the gains you will ever make. Over their investing lives, most investors will be in net loss. That’s sad.
What to do? Should you stop investing in stocks? No, of course. In order to reduce the emotional cost of stock investing, cut yourself from the financial world as much as you can. Don’t check your portfolio too often; once a week or fortnight is just fine. Consume less of financial news and analysis; most of it is useless in the medium to long term. Follow your stock strategy, not market movements. Find other useful pursuits than worrying about stock prices, the economy and the market.
It’s only when you have cut the emotional cost of stock investing that you can proudly say that you have made money in the stock market.
Marketing is a dynamic field. But there are still some old tricks that one can still find around. They have stopped creating an impact and actually become irritable, yet the textbook marketer doesn’t want to let go of them.
Take for instance discounting. Discounting for a short time is fine but if it stays forever, it stops creating the desired impact. Over time people realize that the discounted price is the actual price and there is no discount whatsoever. Worse, some think they have been tricked by making them believe that they are getting a bargain.
Now consider freebies. Marketers try to attract investors with free gifts. If you go for them, you are asked to share your contact details. Some people leave the deal that very moment. Others give fake information. I have created a “junk” email account. If I must part with my contact information, I provide that junk email address. I never worry about the emails in that account.
Many payment applications offer cashbacks these days to entice users. It’s only after you have earned them do you realize that they come with many riders. You can’t use more than a certain percentage of the cashback on one transaction. A highly irritable term is “up to.” The number written after up to is an attractive one. The moment you apply the deal, your payback turns out to be miniscule.
From quoting 9s at the end of the price (299, 399, 999…) to duping you on no-cost EMIs that do entail a charge, to using tricky language, marketers often try to deceive customers. Erroneously, many marketers still think that marketing is about selling a product by using clever means. They spend a lot of time devising ways in which they can trick customers. They think that once the transaction is done, their job is over. That’s a mistake.
Marketing is about providing solutions. It’s about assisting the customer solve his problem. It’s about a life-long relationship. It’s not about fooling people. You might fool your customer once but he won’t ever come to you next time. What’s more, he will spread negativity about your business. The cost of this is enormous in the long term.
What should the marketer do? He should put himself in the customer’s shoes. Would he like it if a freebie required him to share his contact information? Would he like it if having been offered an “up to” 100% cashback, he ended up with just 5%, which can only be used in tranches? If you are giving something away, have no strings attached. If the customer likes your free product, he will come back and pay up for the other things you are selling.
As a marketer, your primary challenge is how to create more and more value for your customer. Invest your energies there.
Lately, many Indian companies have run into trouble. From those belonging to the NBFC sector to the ones hit due to poor corporate governance, the list is long. Unfortunately, many investors (including myself) have had to bear the brunt. Can an investor preclude investing in such companies?
After a scam has been unravelled, business newspapers and magazines are filled with postmortem analysis and how you could have avoided the impacted companies. But that’s all with the benefit of hindsight. Even if someone reliably predicts a troublesome company, how do you distinguish his analysis with the countless other analyses and propaganda against companies doing the rounds. In my view, you can’t always avoid investing in a stock that will turn a nightmare later on. This makes your post-crisis strategy important.
The first leg of your post-crisis strategy actually happens when you make the investment. Invest as per your pre-decided allocation strategy. Don’t go overboard with investing in just one company, no matter how promising it appears and how attractive it has become. Secondly, avoid buying more when the stock price has started to crash. Thirdly, avoid the temptation to sell away (unless you are in profit or making a small loss) just because some news has broken out.
Now the core of your strategy. You are invested in a company that’s caught in some trouble and your stock is already down significantly, say above 25% or, worse, 50%. What should you do? Avoid acting on media reports and wait for more clarity. Media tries to sensationalise things and hence its reporting will likely be nothing short of a doom prediction. Also, media is hungry for developments like these so that they can fill pages. If you sense that there’s indeed some trouble, try to measure its impact and timeline. If some problem is going to be over in the next six months, you might like to hold the stock.
What if you still don’t have clarity but the stock keeps falling? In all such cases, it’s better to start exiting in lots. If it’s a big holding, it can be sold over a year. Smaller holdings can be sold between three to six months. By selling in tranches, you still stand the chance of benefiting from a recovery, which looks elusive when the crisis happens. The impact of the loss also gets distributed. Above all, you save the remaining capital from getting destroyed.
In India, especially in recent times, stocks that faced some trouble have been thrashed to such an extent that a recovery looks impossible. It’s natural for the investor to lose hope. Just formulate a post-crisis strategy and stick to it. Over the long term, if your overall stock selection is good, such losses are neatly absorbed by the gains.
For most of us, good investing is about picking great investments. And that’s understandable. With a plethora of investment options available—many of which are substandard—it’s only natural that we should actively look for “great” investments among them. In fact, many fund managers, private-equity professionals and advisors spend much of their time in finding great investments. Of course, they charge you hefty fees for this service. What if you could identify such investments yourself? You won’t have to pay the fund manager and you will have greater control over your portfolio.
Finding great stocks is easier than you thought. But you will have to open up your eyes. If you track businesses, good businesses are right there in front of you. You deal with them; you consume their products. Such businesses have stood the test of time. In the Indian market, some of such companies are HDFC Bank, Kotak Mahindra Bank, Hindustan Unilever, Dabur, TCS, Maruti Suzuki, Britannia, ITC and so on. Why shouldn’t you invest in them?
Investors face a few problems while investing in this “simplistic way.” Because these companies are clearly visible, they don’t arouse much interest or perhaps thrill. What arouses interest is what’s not widely known—that stock which you discovered after weeks of analysis and that nobody knows about but you. Secondly, the “already discovered” companies are expensive in valuations. Classic investment science says valuations are crucial, so investors give such discovered names a miss. Yet another category of investors feels that large companies can’t give smashing returns as mid and small caps do. Further, some investors feel cheated if you tell them the names of such stocks because they already know them. They want to know something new.
The world of investing has been made complicated for no reason. While most experienced investors and analysts stress the need to be simple, they do just the opposite. This results in countless theories and models that try to pick the “winning” stocks and “beat” the market and the peers. It appears that investing were a game where only one person or a handful of people can win. If you “score” less than your neighbour, you have failed.
Investing in already-discovered stocks should be the core of your investing strategy. Don’t worry about valuations much. Such stocks seldom come cheap, given their quality and robustness. They move slowly but then they also won’t likely fall the way mid and small caps do. Over the long term, the returns from the popular stocks add up to become significant. Invest in them for the long term; don’t get obsessed with short-term ebb and flow in them or their financial performance. Such companies have a history of weathering the storm. In short, they are boring but effective.
Once you have made a core portfolio of such stocks, you can go about hunting for the next stars. This will make your overall portfolio prepared both for the next bull or bear market.
When it comes to bear markets, there are two types of reactions. The first is that of outright dislike (I belong to this camp). No one wants to see their wealth erode, so this reaction is quite understandable. The second reaction is that of excitement, which is not natural but induced. Why be excited? Because now you can buy good stocks cheap.
I doubt the people in the second camp. All they are doing is denying the reality so that it doesn’t hit too hard. If Warren Buffett gets excited about buying stocks cheap, that’s still understandable. But when the guy next door assumes an expression of nonchalance at the latest market fall, I sense fakery. We have been indoctrinated to “not” feel the pain of the bear market and express excitement. That forces us to dismiss the pain of losing money. Worse, we think it’s something to be ashamed about.
Recently, I have started looking at bear markets in a different way. They do cause pain but there is wisdom in that pain. While a bull market makes any rookie believe that he is a star investor, it’s the bear market that unravels your stock-selection strategy. In a bear market, you inevitably have to reevaluate why you did what you did. Most likely, you will find some fault with it. You can’t find these errors in a bull market. Once you fix them, your returns can be even better.
Hence, while bear markets are indeed painful, if you sustain through them, you become a better investor.
If you deny the pain of the bear market, you will have no reason to act on your investment methodology. On the contrary, you will begin buying more of what you own, thus compounding your mistake.
When Buffett gets excited about bear markets, that’s because he has endured multiple bear markets and understands their nature. For most of us, it will make sense to first start appreciating the beauty of the bear.
If you ask a fundamental investor about the importance of the stock price, you will probably get a look of disdain. He will tell you that valuation matters, not the price. Price alone conveys little. Plus he would advise you not to pay attention to the price; just worry about the fundamentals.
The fundamental investor is right. But the problem is that his wisdom is seldom followed. Interestingly, he himself also fails to follow it. You like it or not, stock price is the uncrowned champion of the stock market.
It is the price that creates the narrative. Recently, a company announced its results. Analysts felt that they were mediocre. The stock price should have fallen. The next day, it didn’t. On the contrary, it climbed a fraction. The narrative quickly reversed. After all, the results weren’t bad either.
The problem comes when the stock price becomes the foundation of making a judgement. Because the stock price of a leading bank has fallen, analysts have eagerly engaged in a fault-finding exercise. Similarly, because the stock price of a leading consumer-durables company has been on an up-move, analysts are ignoring its valuations; everything’s hunky dory with the company.
Apart from creating greed/fear in investors, stock price also drives their confidence. It’s not their own analysis or the company’s numbers; it’s the stock price. A falling stock price makes them doubtful; a rising stock price makes them cocky.
What’s the solution then? That’s not easy. Given your biological wiring, the stock price will always influence you. Better don’t see it. Once you have a strategy in place, follow it in letter and spirit. Check your portfolio once a week or fortnight. No matter how good an analyst or investor you are, at a subconscious level, the stock price will influence you if you see it by the hour. That’s the power of the stock price.
