Your New Year’s Resolution: Progressing from the Obvious to the Extraordinary

The time for making resolutions is here again. There is a psychological reason why most people find it hard to live up to the resolutions they make. Just making resolutions doesn’t guarantee that you will follow them. Resolutions have to be backed by a detailed plan of how you are going to follow them. The plan should have a means of measuring your progress as well. Also, it’s better that you have just one resolution in the live state at a time. Trying to follow multiple resolutions is a recipe for failure.

So, what’s that one resolution that you can make this New Year as far as investing is concerned? The one resolution that you can make is to make yourself financially literate. Financial literacy doesn’t mean just knowing about the investment avenues that are out there. It means seeking true investment wisdom. Like most things, the best answers are not available to you readily; they are to be explored. In fact, when you start on the journey of financial literacy, you will first find ordinary answers, the ones that the financial community wants you to know. True investment wisdom will be hidden, and you will have to search for it. Don’t fall prey to what you see readily. The obvious is just a stepping stone to reach the extraordinary, so don’t stop at the obvious itself.

How do you reach the extraordinary? By reading works of the people who are extraordinary. What your financial advisor tells you or what you see on television or what gets printed in newspapers isn’t the extraordinary; that’s the obvious. Here is a short list of the books that you can begin your financial-literacy journey with. After you have read these books, don’t stop. Keep exploring new resources. That’s how you will progress from the obvious to the extraordinary.

Rich Dad Poor Dad by Robert T. Kiyosaki
One Up on Wall Street by Peter Lynch
The $100 Startup by Chris Guillebeau
The Secrets of the Millionaire Mind by T. Harv Eker
Increase Your Financial IQ by Robert T. Kiyosaki
The Art of Thinking Clearly by Rolf Dobelli
What Works on Wall Street by James P. O'Shaughnessy 

Stock Price: The Most Important Stock Parameter

From the debt–equity ratio to the interest-coverage ratio, from cash flows to operating profit, traditionally, analysis of stocks has entailed myriad parameters. Stock analysts have their pet parameters against which they try to evaluate stocks. Indeed, one of the greatest quests in the stock market is to find a parameter or a combination of parameters that can find winning stocks most precisely. Unfortunately, no one has found one yet, though many people may claim they have. In my view, the most important parameter has always been there in front of us: the stock price.

Many seasoned investors may be amazed at the last statement. How can stock price be most important? Stock price is most important because your profits (and losses) in the market are governed by it. If you buy a stock at 100 units and sell it at 200 units, you make a profit of 100 units because the stock price reached the level of 200 units. If it had sunk to 50 units, you would have lost 50 percent of your money. So, you win or lose because of this “insignificant” thing called the stock price.

Still confused? To put it simply, in order to succeed at stock investing, it's important that you follow a strategy that is directly linked to the stock price. Ask yourself: What causes the stock price to go up? Then craft a strategy around this. Stock Market Investing for Employees discusses the EPS approach, which is based on the notion of the stock price. The approach says that the companies that grow their earnings at a reasonable rate over time see their stock prices moving upward.

A complete disregard to what causes the stock price to move and focusing on other distantly-related parameters will only prolong your quest for profits. The fundamental analyst is so engrossed in his own paraphernalia of tools that the stock price is the last thing that comes to his mind. The value investor turns a blind eye to the stock price as well. For him intrinsic value is more important than what the stock price is reacting to. Many investors are willing to sit over low to negative returns for years just because they prefer some other “magical” formula. Perhaps a technical analyst is more astute because much of his analysis is based on the stock price.

The conclusion is that no matter what strategy you follow, just see how well it relates to the stock price. If the relation is tenuous, profits may evade you for long. If the link is clear, you are very likely to make money.           

The Loss Phobia: Why Booking a Loss Isn’t a Bad Idea

The other day I was talking to someone. He told me how his portfolio had an investment that wasn’t performing. In fact it had been over a year that the investment wasn’t performing. He also understood the problem with the investment, yet he wasn’t willing to part with it. Why? Because he was making a loss of some 2-3 percent on it. He wanted the investment to come back to the purchase price so that he didn’t have to book a loss on it. Maybe he was suffering from the loss phobia, and, mind you, he isn’t alone. Many of us are programmed to see losses on investments as something unacceptable or as a blow on our egos.

When it comes to investing, booking a loss is the part of the game. Talking specifically about stocks, you can’t have all your bets right on target. Some of them will go haywire and run into losses. Just because a stock has run into losses doesn’t mean that it’s a bad stock. It’s actually normal for stocks to fluctuate (in many cases wildly) up and down. However, when the company backing the stock does poorly, it may be necessary to sell the stock. Stock Market Investing for Employees discusses in detail how you can deal with such stocks and know when to wait and when to sell out.

The core point is that selling at a loss isn’t a bad thing. It’s about appreciating the fact that you are invested in a bad stock and coming out of it timely so that you can contain your losses. To emerge out as a winner in the investing game, your performers need to outdo your nonperformers by a sizable margin. So, you need not be correct all the time.

The longer you stay invested in a bad investment in hope that it will someday come back to your purchase price, the larger your “loss” will be. This is because you will forgo other good opportunities in the meantime in which you could have invested the money that is stuck in the bad investment. Losses are a normal part of the business world. Many good companies also run into losses at times. When you invest in the market, you are in the business world as well. So, you should see losses as part and parcel of the game and not as something that you should be ashamed of or should try to nullify.
 

Travestor: The New Category of Stock Investor

Time and again I have come under criticism from the people around me for selling stocks “too soon” in order to make profits. A few have said that I am a “trader” and not an “investor.” In the world of investing, the term “trader” has got a negative connotation. It stands for a person who does all kinds of somersaults and jugglery to produce minuscule profits. The intensity with which the investment fraternity balks at the idea of trading makes it look like some ultra antihuman activity.

Well, to dispel all doubts, I am not a trader in its classical sense. And I am not necessarily a long-term investor. The time for which I hold a stock is immaterial to me. What matters to me is the selling price. Stock Market Investing for Employees introduced the EPS approach, which lets you calculate the selling price for a stock. It’s the selling price that dictates how long I hold onto a stock. If the selling price is far away and takes a long time to come (during which the stock keeps fulfilling the investment criteria), I become a long-term investor. If the selling price comes the next month, I am out of the stock and you may call me a trader. Those who have a difficult time categorizing this approach may call it “travesting”—a combination of trading and investing.
  
Every day the market throws a price at you for your stock holdings. The successful investor knows when to accept the price. Since most don’t know when to, they take shelter in the idea of long-term investing, which only absolves them from taking responsibility of their stock investments. Long-term investing is not mandatory; it makes sense only when the stock you own will take a long time to fully realize its potential. For example, if the selling price is away by 500 percent, you may have to hold the stock for the long term. But if the same stock goes up 500 percent in less than a year (it does happen, don’t be surprised), you are expected to sell out.

Travestors also realize that they are in the market for making money, not to live up to some traditional, sacrosanct theory like long-term investing. They care not about trading or investing but about their profits.

Blinded by Buffett: Why Buffett May Have Done More Harm than Good to Stock Investors

When it comes to stock investing, the one name which commands most admiration is Warren Buffett. Indeed, Buffett is the greatest investor that stock markets over the world have witnessed, yet he may have done more harm than good to stock investors.

Swarms of investors—both new and experienced—live by Buffett's wisdom. In this process they tend to apply his tenets of investing, about which they come to know through the annual reports of Berkshire Hathaway. Mountains of books have been written on Buffett's style, the primary source of which is again his speeches in Berkshire's annual letters.

Assuming that the content about Buffett in circulation is correct, the problem with aping Buffett's methods remains that most people can't imitate them. Take the concept of “moats,” for example. A moat is a company that has some competitive advantage that can't be encroached upon. Novice investors, and for this matter even experts, don't have an idea of how to find out moats. I have seen people interpreting just anything as a moat and then feeling proud of their intelligence. Though the stock price keeps sliding due to lower profitability, the “value investor” keeps clinging to the stock in the hope that it's a multi-bagger with some “temporary” problem.

The availability of role models, like Buffett, is both a good and a bad thing. Sure we all can learn something from our role models. However, when we try to imitate them, we may not succeed. What works in the stock market is originality and a well-crafted stock strategy that you can stick to. You must find your own winning formula. There are multiple ways in which you can make money in the market, so you need to find one that works for you. What worked for Buffett may not work for us, for we don't have his mind.

Neither do you need to set Buffett as your benchmark. Most small stock investors buy just a few shares of a company, unlike Buffett, who buys the entire company. Though his investment track record may be enviable, yet you should aim at getting “good” returns rather than “Buffett-like” returns. This simple change in mindset will increase the chances of your success manifold. 

The simpler your approach is the better it is. Complex models and methods are not only difficult to implement, the market also doesn't care about what method you are using. We need not be Buffett;  we can succeed in the market being ourselves and following our methods as well.

Returns vs. Offer: Why You Should Not Be Very Happy about Your Returns?

Booming markets see a lot of people beaming with pride because their portfolios have gained significantly. As bulls take charge, the grin on investors' faces only gets wider, as they see their portfolio worth inching upward. On the other hand, in bear markets many of us shy away from discussing our portfolio performance. This is because our portfolios are losing money and hence showing negative “returns.” The so-called “returns” figure seems to have become the benchmark of success in investing in spite of the fact that it is highly flawed.
 
The “returns” figure on which many of us focus so much is an illusion. If your stock portfolio is up by 10 percent, it means nothing! You haven't got that money in your hand. Similarly, just because your portfolio is down 10 percent, that again means nothing; you won't lose a penny unless you sell. Moreover, given the nature of the market, it’s foolhardy to read too much into your returns figure because they can fluctuate wildly. Today your portfolio is up 10 per cent; tomorrow, it may be up 8 per cent; a week hence, it may be down 5 percent. Even one good or bad year can severely impact your multi-year returns. All in all, the “returns” figure is highly unreliable unless those returns have been booked.
 
Interestingly, the word “returns” is a wrong word to use because you haven't gotten anything in return; what actually have is an “offer”—an offer to sell your stocks and you will gain/lose so much. Unless you act on the offer, you haven't made or lost any money.

The implication works both ways. Don't get too happy because your portfolio is showing a positive offer and don't get too disappointed because the offer is negative. The market comes to you every day with an offer, and that's how it is. Only when you sell your stocks does the offer become your returns. That means to make money in the stock market you are very much expected to sell your stocks. Buying a good stock is only half the thing. Knowing when to sell is as much important as, if not more than, knowing when to buy. The key to making money in the market is summed up below:

1. Spotting good companies available at a bargain
2. Holding onto their stock till it gets appropriately priced
3. Selling it
4. Putting the proceeds back in other good companies trading at a bargain
5. Repeating the above steps

So, don't get too excited (or dejected) about your “offer.” Accept the offer when it's the right time to do so. Once you have made “real” profits, that’s the right time to tell everyone about your “returns” with an inflated chest.

Why You Should Be Wary of Long-Term Investing

It's always risky to challenge a belief that has wide currency among people. This is not only because we like to keep a tight grip over our beliefs, but also because by the time we realize the truth we may have already made a huge commitment and it is difficult to retract now. Nonetheless, it is always in one's interest to at least understand, if not wholeheartedly accept, the contrary perspective.

One widely accepted and sacrosanct belief is long-term investing. The financial community teaches the merits of long-term investing in unison. “Invest for the long term and you will do well”—this is the jingle which accompanies almost every statement that the financial community makes. Indeed, it has examples to cite that support the belief. The most frequently given example is of the market index, which has gained significantly over the long term. So, as the argument goes, if you had invested in the market ten years ago, you would have made fantastic gains. When you weigh the argument against reason, you have no other option but to believe it.

However, things aren't so simple. Consider the following points:

What if the long-term investing theory fails to work in your case? You are a long-term investor and you believe that everything will eventually turn out to be okay. What if you get a bad surprise after many years of having made your investment? Will you have time to undo the effect? Let's say you buy a financial product today and wait patiently for ten years to allow it to work. Ten years hence you notice that the investment has given paltry to no (or even worse, negative) returns, what do you do now?

The long-term investing idea is the ultimate cover-up for lack of performance: Your financial product isn't performing, but you hold onto the product because you are told that over the long term it will do well. You own the stock in a company which is doing poorly, yet you don't exit from it because you think that over the long term it will recover and deliver returns.    

The long-term investing idea relieves you from the responsibility of tracking your portfolio: Since you are invested for the long term, you don't make any decisions and justify your inactivity by saying that you need not make any decisions in the short to medium term. When you are investing in stocks, you are in the business world and you have to be periodically making decisions. You should be consistently monitoring your portfolio to determine what to buy and sell. You should be consistently monitoring your companies' performance. Now I am not saying that you worry about your stocks on a daily basis. All I am saying is you can't really set your hands off them completely for a prolonged period of time. That's a recipe for disaster.

Long-term investing can result in unnecessarily waiting for “better” results: Stocks don't always follow the long-term rule. A stock can very well appreciate in a couple of months and hit a high level. When the market is willing to pay you an excellent premium on your buying price, you should be willing to sell. However, the long-term theory keeps you from selling “early.” Unfortunately, as the bull run in the stock fizzles out and it goes down, you lose the opportunity. What's more, you still hang onto the stock as now you have seen it attain a higher level and you would rather wait for that level to arrive again—of course, over the long term.     

Your long-term mindset works in favor of the financial community: The financial community gets to keep your money for the long term. Its accountability for results also reduces if you believe in the long term. Warren Buffett, the iconic investor, had sold off all his stocks in 1969 as the valuations were rich. He stayed out of the market for around two years after that. Will a fund manager do so? He can't because the company wants the fund running. He can't sell off the entire stuff and sit on cash. In fact, as the new money comes in, he will be buying the stocks in his investment universe, no matter what the valuation. Since he will have bought stocks at high levels, he will have to stay invested for the long term to deliver returns.

So, the conclusion is that in the stock it isn't important that you stay invested for the long term. What is important is that you buy, sell, and track your portfolio as per a fixed strategy. It doesn't matter if you are invested for the long term or the short term. What is important is that you sell as per your strategy. Since the selling price of a stock may be far from the buying price, holding the stock for the long term may become necessary, yet it's not indispensable. You can as well make profits in the short to medium term.

 The writer is the author of Stock Market Investing for Employees.