Deep Truth about the Markets and Investing

The Federal Reserve isn’t nearly as powerful as is commonly believed.There isn’t a person or group of people in charge of the market.

There’s no such thing as a “healthy correction.”

Good stocks can go down for no reason.

Bad stocks can go up for no reason.

A trend can last much longer than you thought possible.

Stocks don’t know you own them.

The market doesn’t care about politics.

The most important variable to the stock market, by far, is the direction of long-term interest rates.

Mega-mergers rarely work.

Investment bubbles aren’t due to the moral failings of the market participants.

Ignore anyone who tells you that the Federal Reserve is a private bank.

Commodities are almost always terrible investments.

The stock market hates inflation. The only thing it hates more is deflation. The best environment for stocks is a low stable inflation rate.

As an investment tool, P/E Ratios work much better for individual stocks than for the market as a whole.

The best three fundamental metrics are (in order) ROE, Debt Ratios and Cash Flow.

Wherever possible, seek out stocks with expanding margins.

Dividends are underrated by investors, especially companies that consistently raise them.

Portfolio diversity is overrated.

As a general rule, IPOs are a bad deal.

Boring but profitable always beats exciting and unprofitable.

CAPM and MPT are nonsense.

No one can consistently time the market. No one.

The Equity Risk Premium (over long-term debt) is probably much smaller than commonly believed.

The data showing a return premium for small-cap stocks is probably wrong.

The media never questions the bond market. Only stock investors are “greedy.”

Perma-bears are never held to account for being wrong so if you want to sound smart, be very bearish and very vague.

The market really does “climb a wall of worry.”

Follow unfollowed stocks.

The market is self-aware. Scary but true.

It’s far easier to rationalize selling than buying.

The market isn’t efficient—it can be beaten.

But it’s very, very, very, very hard.

Most technical analysis is complete garbage.

A high P/E Ratio is much better sign of a stock to sell than a low P/E Ratio is a sign to buy.

It’s pointless to measure the stock market relative to gold or in euros or pork bellies or whatever else people can come up with.

Ignore any chart that has seemingly similar lines trying to show how this market is “just like’ the one in 1831.

Except at very low levels, volatility is neutral.

Many gold bugs are quite simply fanatics.

Whatever the issue, your typical finance professor will blame the investing public and urge more self-denial as the solution. Bank on it.

Never base an investment decision of demographics.

The worst investor in the world is the guy holding on to a small loss waiting for the rally because “they don’t want to take the loss.” Again, the stock doesn’t know you own it.

Very, very few serious companies are traded on the pink sheets.

Never stress out about what a stock does after you sell it.

Start investing early, stay with SIP through thick and thin

Driving to work is an ordeal: traffic snarls, honking, a two-wheeler grazing my car's sideview mirror and a delayed entry into office. Last week, I happened to leave home 15 minutes earlier than usual. Miraculously, driving was a pleasure. 

There was traffic on roads, and auto-rickshaws were performing acrobatics too; but I seemed oblivious to them. It took me some time to realise that because I had enough time to reach my destination, I was less stressed and I made it on time to my office, even whistling as I walked in. That's possibly what happens to investors who start executing their plans early, I thought.

We see mutual fund advertisements screaming out of billboards and newspapers boasting of their performance over the recent and not-so-recent past.

I tied a blindfold to the short-term returns, as I know that equity investing is for the long term; and viewed their returns over the past five years.

I could calculate and then salivate at the notional gains I would have made had I invested in the index (using the Nifty for comparison) then: had I put in Rs 3 lakh five years ago, my investments would be worth Rs 7.16 lakh, or a return of 19% p.a, compounded annually. I brought myself back to reality quickly as I realised that I would not have had that amount to invest at one go in 2005.


The possibility that I could have made a profit of over Rs 4 lakh in the past five years continued to haunt me. 

Some quick calculations later, it dawned upon me that I could have easily kept aside Rs 5,000 per month during that time, and Rs 3 lakh would have been in my piggy-bank.

Obviously, since not all the money was put upfront, my absolute returns would be lower. Had I invested a regular amount in the Nifty on a monthly basis, my returns in the past 5 years would be a healthy 13.7% pa on a compounded basis. That would have resulted in my investment growing to Rs 4.27 lakh today, or an absolute return in excess of 40%.

Then, I found a mutual fund statement (can't tell you whether it was mine — confidential!) where Rs 5,000 per month was invested in a systematic investment plan for the past 5 years in a largecap fund.

I was thrilled to see the results (see table). The value of this investment was Rs 5.44 lakh, or a return of over 80% in the past 5 years.

Moreover, these returns were achieved with a total peace of mind — once the systematic investment plan was started, it went on without a pause and irrespective of market movements.

It was then that I turned to the mutual fund factsheet for this scheme and the results for systematic investment of the same amount of Rs 5,000 in the past 10 years blew me away. In this case, the total invested amount would have been Rs 6 lakh and the fund value was over Rs 41 lakh. Now, I would have settled for this any time.

What this taught me was: start investing early, stick to equities for the long-term , continue your systematic investment plan — come thick or thin.

Make sure you start driving to office early and watch your productivity soar. Investments follow pretty much the same rules.

The one quality that sets investors apart

In most economic activities, a great deal of enthusiasm is a great asset. In fact, most entrepreneurs who make it big tend to be extremely driven. They pour a great deal of energy into executing tasks rapidly. Invariably, that is how they propel their firms to great heights.

Since investing in equities also has to do with businesses, surely enthusiasm must be a great asset here too. Not quite.

Investors must avoid enthusiasm

"While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster." - Benjamin Graham

But why is enthusiasm so dangerous in investing? Primarily because of the heuristics and biases inherent in our behavior. There are strong tendencies such as confirmation bias, herding and social proof that make investors enthusiastic at the wrong time. Often that time is when the markets have posted strong returns. Money making becomes too easy. Investors suddenly feel terribly enthusiastic. In other words they turn greedy. Businesses that are considered strong and have good prospects are given fancy multiples. Steeply priced initial public offerings (IPOs) are lapped up. Once that happens, all the excellent qualities that an investor brings to the table are put under a severe burden. To quote Benjamin Graham again, "It is no difficult trick to bring a great deal of energy, study, and native ability into Wall Street and to end up with losses instead of profits. These virtues, if channeled in the wrong directions, become indistinguishable from handicaps."

Patience

"All man's miseries derive from not being able to sit quietly in a room alone." - Blaise Pascal

The strongest antidote to the dangers of enthusiasm is patience. The reason is simple. In most economic activities, the results are an accumulation of several of decisions. When it come to investing for the long term, the 'buy'decision is disproportionately important. 'What you buy' and 'at what price'. In fact, Warren Buffett often says that if you get the 'buy' price right, you will do rather well for yourself even if don't time the 'sell' to perfection.

Since it is not possible to get the right prices everyday, investors must exercise patience. Mohnish Pabrai, the author of 'The Dhando investor', once wrote an interesting article titled 'Buffett succeeds at nothing'. He mentions how Warren Buffett and his partner Charlie Munger go through multi-year periods where they essentially just wait for the right prices. What do they do during that time? Play bridge, read book, study companies. They exercise patience.

The most successful style of investing...

yet very few people practice it.

"The secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years that I've practiced it." – Warren Buffett, 1984

It has been another 25 years since Warren Buffett said this. But the statement still rings true. He is now even more famous than before. The number of books on him has multiplied and business channels now have divisions that track his activities on a daily basis. While Buffett is the most famous, there are others who are successful value investors in their own right and also receive ample media attention.

But if you looked around to see how professional money managers go about their business, you wouldn't find too much of value investing there. The logical question then is ‘Why not?’ We believe there are certain behavioral stumbling blocks that explain why there are very few value investors despite all the media coverage the discipline receives.

Knowledge doesn’t translate to action
Unfortunately, knowledge doesn't always translate to behavior. It is common knowledge that we should use helmets, buckle up our seat belts, avoid smoking, take medical insurance etc. but we don’t strictly follow them. It takes deliberate action on our part for us to form habits, mere knowledge is not enough. If we are not able to always do the right thing in such important matters, it is not surprising that we don't choose the best path when it comes to investing.

One size doesn’t fit all
The general tendency of investors is to find that magic formula - a method that applies to all situations. In fact, the one time everyone asks for stock tips is when there is market euphoria. The right answer during such times is – ‘don’t buy anything’. But that’s a difficult answer to digest. On the other hand, when markets are unduly pessimistic, there are value picks everywhere. Value investing often doesn’t offer picks when we are most interested. That makes it a hard discipline to follow.

Patience in the internet age?
A few months ago Bharti Airtel had come out with a campaign called the 'impatient ones'. That seems to be an apt description of most investors. The way we have evolved, we are hard wired for short term rewards. Short term thinking comes naturally to us. It takes training and mental conditioning for us to shake off the habit and reorient our investment horizons. Value investing requires long term time horizons because there is no guarantee that out of favour stocks that value investors prefer investing in, will suddenly come back in favour.

Standing out from the crowd is difficult
As explained above, the best value picks come exactly at the time when there is pessimism all around. As Buffett himself said, "The most common cause of low prices is pessimism - some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.' Unfortunately, that means one has to do the exact opposite of what others are doing. Buy when others are desperately selling and vice versa. Since we are hard wired to stick to the crowd, it is inherently difficult for us to do the exact opposite.

To conclude, it is not the lack of intelligence or knowledge because of which there are so few value investors. The answer lies in our behavioral pitfalls. We need to master them in order to practice value investing.

25 Best Warren Buffett Quotes

On Investing

1. “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”
2. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
3. “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
4. “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
5. “Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful”.”

On Success

1. “Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.”
2. “The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.”
3. “You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.”
4. “Can you really explain to a fish what it’s like to walk on land? One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value.
5. “You only have to do a very few things right in your life so long as you don’t do too many things wrong.”

On Helping Others

1. “If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent.”
2. “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
3. “I don’t have a problem with guilt about money. The way I see it is that my money represents an enormous number of claim checks on society. It’s like I have these little pieces of paper that I can turn into consumption. If I wanted to, I could hire 10,000 people to do nothing but paint my picture every day for the rest of my life. And the GNP would go up. But the utility of the product would be zilch, and I would be keeping those 10,000 people from doing AIDS research, or teaching, or nursing. I don’t do that though. I don’t use very many of those claim checks. There’s nothing material I want very much. And I’m going to give virtually all of those claim checks to charity when my wife and I die.”
4. “It’s class warfare, my class is winning, but they shouldn’t be.”
5. “My family won’t receive huge amounts of my net worth. That doesn’t mean they’ll get nothing. My children have already received some money from me and Susie and will receive more. I still believe in the philosophy - FORTUNE quoted me saying this 20 years ago - that a very rich person should leave his kids enough to do anything but not enough to do nothing.”

On Life

1. “Chains of habit are too light to be felt until they are too heavy to be broken.”
2. “We enjoy the process far more than the proceeds.”
3. “You only find out who is swimming naked when the tide goes out.”
4. “Someone’s sitting in the shade today because someone planted a tree a long time ago.”
5. “A public-opinion poll is no substitute for thought.”

Funny Ones

1. “A girl in a convertible is worth five in the phonebook.”
2. “When they open that envelope, the first instruction is to take my pulse again.”
3. “We believe that according the name ‘investors’ to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic.’”
4. “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
5. “In the insurance business, there is no statute of limitation on stupidity.”

The Efficient Markets Hypothesis

5 things to know before investing

All of us need to manage our finances wisely. While some aspects of financial management change with age, the basic principles of good financial habits and planning remain the same throughout one's life. Here are a few things that should be kept in mind at all times before investing:

THE GOAL

If you have a goal that you are trying to achieve, then it becomes easier for you to track your progress and analyse whether your investment strategy makes sense or not. It is very important to be well aware of targets before planning to invest

THE TIME

Once you have identified your goals, understand over what time period you want to achieve your goals. This will not only keep you focussed and motivated, but will also keep you alert of the risks involved

THE RISK

Every investment has risks associated with it. Every individual should take risk according to his or her capacity. Some investments are risky than others. Before investing, it is good to know your capacity to take risks so that there are no jolts later

THE INFLATION

In a fast-growing economy, inflation is a fact of life. Manage your investments accordingly. For instance, stocks would offer better protection than fixed deposits against inflation

THE LIMITATIONS

It is always good to stay within your means. Stay away from 'bad debt' — debt you take for consumption purposes, otherwise you could risk falling into the debt trap where you have to borrow more to pay off your previous debts