Warren Buffett on Market Fluctuations

From 1997 Letter to Shareholders:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

For shareholders of Berkshire who do not expect to sell, the choice is even clearer. To begin with, our owners are automatically saving even if they spend every dime they personally earn: Berkshire “saves” for them by retaining all earnings, thereafter using these savings to purchase businesses and securities. Clearly, the more cheaply we make these buys, the more profitable our owners’ indirect savings program will be.

Furthermore, through Berkshire you own major positions in companies that consistently repurchase their shares. The benefits that these programs supply us grow as prices fall: When stock prices are low, the funds that an investee spends on repurchases increase our ownership of that company by a greater amount than is the case when prices are higher. For example, the repurchases that Coca-Cola, The Washington Post and Wells Fargo made in past years at very low prices benefitted Berkshire far more than do today’s repurchases, made at loftier prices.
At the end of every year, about 97% of Berkshire’s shares are held by the same investors who owned them at the start of the year. That makes them savers. They should therefore rejoice when markets decline and allow both us and our investees to deploy funds more advantageously.

So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: “Every putt makes someone happy.”)

We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence. In recent years, the actions we took in those decades have been validated, but we have found few new opportunities. In its role as a corporate “saver,” Berkshire continually looks for ways to sensibly deploy capital, but it may be some time before we find opportunities that get us truly excited.

In a Fire Sale Think about Entry, not Exit!

The old adage that the market operates on greed and fear has been well-exemplified over the past few months. It is never savory to witness paper losses, and there are few fears as strong as losing one’s hard-earned money in a violent, abrupt market correction. In an environment where FIIs have been selling their wares at fire-sale prices to meet margin calls and recapitalization requirements in their home countries (or to simply avert bankruptcy), it may seem that the time has come to book losses, exit the market and re-enter at a more opportune time. However, there are several logical reasons why it does not pay to overreact…read on to understand why.

1. Market Timing never wins

A natural human reaction to a sudden plunge in the markets would be to run for safety by reducing or liquidating one’s exposure. The base instinct is to stem loss of capital and eventually re-enter the market at a more favourable juncture. However, repeated studies have shown that market timing, i.e. trying to perfectly time entry and exit points, seriously damages investor’s long-term returns. As the historical long-term trend of the stock market has been upward, one must recognize that there are significant risks with trying to accurately time the market’s peaks and troughs in search of abnormal gains. This strategy typically results in:

i. High exposure to stocks at the peak of bull runs (just prior to a sell-off), and
ii. A reduction of holdings in a deep bear market, just before of a period of stellar appreciation.

Essentially, timing the market puts one at risk of selling low and buying high, and is a sure-fire way of guaranteeing disappointing returns. Perfectly timing entry and exit points sounds good in theory, but usually fails in practice. The direction of the market can change rapidly, and market rallies can occur suddenly and over very short periods. Further, attempting to move in and out of the market can be an extremely costly affair, particularly because a significant portion of the market’s gains over time tend to come in concentrated periods. Missing out on just a handful of the best-performing days in the market may leave investors at a significant performance disadvantage compared to investors who remain fully invested for the long-term.

2. Markets Do Recover

First, one must recognise that no two crises are alike. The paths that each crisis takes, and the institutions they decimate, are always different. In the current scenario, what started out as a boiling over of the U.S. housing market and over-extended banks resulted in a chain-reaction across the globe, claiming victims in diverse places from Russia and Iceland to Argentina. Volatile markets are by definition highly unpredictable, and a case in point is the U.S. Dollar. While one would expect that the currency of the country suffering the most would fall in value rapidly, the reverse has happened. The phenomenon of de-leveraging and unwinding of global assets by FIIs has resulted in huge demand from them for U.S. Dollars to repatriate back to their home countries.

The ensuing liquidity crisis in India, coupled with negative psychology and sentiment, has resulted in tight credit conditions across the economy. But history shows us that corporations learn to tighten their belts, governments induce liquidity and confidence-building measures, pricing re-discovery begins, and eventually the tide turns. Declines in the equity markets are not uncommon, and as mentioned previously, such periods of sudden turmoil have been normal occurrences in the market’s long-term upward trend.

3. Emotions ? Wealth Creation

Fleeing stocks for the safety of Gilts or CDs or Liquid Funds may seem quite appealing at times, especially when the market takes a sudden plunge on a negative news headline. In times of turmoil, it can be difficult to take a long-term view and resist the urge to react to the latest market swing. For short-term financial needs, cash and cash-equivalent investments can be good choices. However, they are not suitable for long-term wealth creation, because the returns are likely to be too low – your investments need to outpace inflationover time, otherwise your purchasing power is eroded. Historically, it’s been equities that have helped investors compensate for inflation by delivering higher average annual returns than cash or debt investments.

The need to keep an investment allocation policy constant is thus necessary for wealth accumulation. One can always alter the allocation to meet changing lifestyle needs and requirements, when it makes sense to revisit your investment plan due to meaningful changes in your life – the change should be driven by something significant and permanent. On the other hand, booking losses or making sudden, abrupt changes in line with market declines would not get you where you want to be. Keep in mind that 21st century technology and medical science advancements may help you live 80, 90 or even 100 years! With extended investment horizons the effects of inflation and the preservation of purchasing power need to be seriously considered. Staying calm can help investors avoid making moves they later regret. And emotional decisions more often than not lead to regrets.

4. Crisis = Opportunity Scale UP, not down!

To paraphrase the old sage of the markets, Warren Buffet, when others are fearful it is time to be greedy and vice versa. As painful as they are, market downturns can serve as reminders of the risk inherent in the market. It is precisely because stocks are a volatile asset class that they have historically provided a higher rate of return relative to other major asset classes, such as debt or cash. Market participants expect higher returns to compensate them for taking on additional risk. As a result, market fluctuations are the norm and not the exception, and short-term fluctuations are inevitable in the long-term upward trajectory of the market.

That is why some of the best periods to have entered the stock market have been during periods of particularly negative sentiment and extreme market turbulence. Hindsight suggests that during challenging economic episodes in history, investing more in stocks has been a prudent decision. While having the fortitude to stay invested provides an opportunity to fully participate in the market’s long-term upward trend, investing additional money has proven to be the kicker that can generate large returns in one’s portfolio. Waiting until sentiment feels positive again to make an investment has typically not been a good method of achieving future returns. Many of the best periods to invest in stocks have been those environments that were among the most unnerving.

5. Technicals vs. Fundamentals

When market technicals and perception start overriding the fundamentals, the question we ask is how is it that a large, blue-chip corporation is suddenly worth 20% or 30% less than a week ago or a month ago? Is the sell-off justified by the underlying economic and corporate fundamentals? Is the market becoming too pessimistic? Or is the sell-off in line with diminished expectations for economic growth, profitability and balance sheet performance in the coming months?

Whenever panic-induced selling begins, prices can become much cheaper than justified by their intrinsic value. This is the reverse of what typically happens in a hyper bull-market run. Valuations can become irrational on both the up-swing and down-swing. This is no doubt a tremendously challenging time for investors, but panics can cause prices to fall further than might be appropriate based on the underlying fundamentals. While nobody has a crystal ball to predict when exactly the bear market will turn around, you can be assured that as long as the entire world’s economy does not collapse overnight, it is low valuations that will eventually set the stage for the next bull-market rally.

Index funds good for passive investors

Index funds have been popular with investors. Over the last year, the returns from index funds have been pretty good - about 30 percent. This is higher than the returns equity schemes posted in the market .

An index fund is a type of mutual fund that invests in securities of the target index in the same proportion or weightage. Index funds are targeted to popular indices like the BSE Sensex or Nifty. There may be index funds benchmarked to sector-specific indices as well. For example, pharma, IT or FMCG sector indices.

These funds are expected to provide returns that closely track the benchmark index and are also subject to all the risks associated with the class of securities invested in. When the market falls, the securities comprising the index fund also fall, and the returns from index funds fall too. Their objective is to ensure that the returns do not vary far from returns from the index that the fund is linked to. These funds do not eliminate or reduce market risk.

Index funds are used by investors who are risk-averse . In comparison to actively managed funds, index funds have lower expense ratio, lower transaction costs, better control of risk through diversification and less prone to risk of fund manager's performance. Among institutional investors, index funds are used by pension and insurance funds.

Among individuals, investors who do have knowledge of the markets or are averse to sector-specific risks prefer index funds. Index funds can be either for equity funds or debt funds. Indexing is popular with investors who prefer steady returns through a conservative, long-term and lowrisk investment strategy.

Indexing is an investment approach that attempts to match the investment returns of a specified stock market benchmark or index. The fund attempts to replicate the investment results of the target index by holding all or a representative sample of the securities in the index. No attempt is made to use traditional stock management, take positions on individual stocks, or narrow industry sectors in an attempt to outpace the index.

Indexing is a relatively passive investment approach. Index funds are generally evaluated on the basis of the tracking error, i.e., the annualised standard deviation of the difference in returns between the index fund and its target index. It is the difference between returns from the index fund to that of the index.

An index fund needs to calculate tracking error on a daily basis. The lower the tracking error, closer are the returns of the fund to that of the target index. The tracking error is calculated against the total returns of the index, inclusive of dividends.

It indicates how closely the fund is tracking the index. It refers to the ratio of how close the weightages of the stocks in the portfolio are to the weightages of the stocks in the index. The more closely the weightage of the stocks are tracked in the index, lower will be the tracking error.

The factors that affect tracking error are inflows or outflows in the fund, corporate actions, change of index constituents, level of cash maintained in the fund, costs that are routinely deducted from fund returns like transaction costs including commissions , bid and ask spread, etc.

The higher the expenses incurred, greater will be the tracking error. Because of the tracking error, the returns from the index funds are usually lower than the benchmarked index. However, in case the tracking error is zero or negative, the index fund may deliver returns superior to that of benchmarked index.

Index funds are primarily meant for the passive investors. The portfolio of the index fund comprises stocks in a particular benchmark index. The composition of the portfolio is similar to the benchmark index, any movement in the underlying index would affect the fund. The NAV of the scheme replicate the underlying index. So the investor can swim and float with the index.

These funds are cost-effective . The schemes are pretty transparent. The investor knows in which companies his money is going to be invested. For example, if one invests in an index fund linked to the BSE Sensex, the investor knows that his money would be invested in the companies comprised in the BSE Sensex only and not in any other company. These funds are ideal for investors having a medium term view of the market.

As presently the stock markets are subdued , and are expected to rise in the times to come - over a time horizon of 1-2 years - one may consider including investments in index funds in his portfolio to get good returns.

Do expenses really matter?

Do expenses really matter?

Having discussed the various costs and expenses involved while investing in a mutual fund scheme, let’s now find out if they really matter. To understand this better, we shall compare two mutual fund schemes, one with a low cost structure (say Fund A) and the other which isn’t quite as charitable (say Fund B). Investments in Fund A attract an entry load of 1.0%, while the number is 2.5% for Fund B. Similarly, the recurring expenses are 1.5% and 2.5% for fund A and fund B respectively. Assume that Rs 100,000 (one-time investment) is invested in each fund for a 10-Yr period and that both the investments grow at 15.0% per annum.

Fund A vs............... Fund B
................................Fund A ........Fund B
...........Entry load................ 1.00% ............2.50%
Recurring expenses............ 1.50% ..............2.50%
Amount invested ........(Rs) 100,000.......100,000
Growth rate (per annum)...... 15.00% ............15.00%
Maturity amount 10 yr (Rs) ...344,331 ........306,217

On maturity (i.e. at the end of 10 years), the investment in fund A would be worth Rs 344, 331, while that in fund B would be worth Rs 306, 217. The differential can be traced to Fund A’s cost effectiveness.

While evaluating a mutual fund scheme, factors like the AMC’s investment philosophy and style, track record across parameters (risk and return) are usually given due weightage. To that list, investors would do well to add the fund’s cost efficiency. After all, as we have observed, over the long-term the costs involved can have a significant impact on the fund’s performance.

Stock market still trading 25-30% higher

In the high-flying world of equities, it’s seldom that investors talk about dividends. This is surprising; given that one of the best things about investing in a well-managed company is that it provides investors with regular tax-free dividend income that also grows along with the company.

In fact, for purists, the truest form of investment is the one that is done for dividends. Everything else is speculation, with varied time frames.

But do dividends teach us any lesson, given the current meltdown? And do they help in our efforts to find the bottom? An ETIGanalysis suggests that the answer to both these questions may lie in the history of dividend payouts of listed companies rather than their forward-earning estimates, as many traditionalists will like to believe.

A historical trend line of the dividend paid out by Nifty companies offers interesting insights — the current bull run began in April ’03 at an all-time high dividend yield of about 3.2% and the correction in January ’08 began at a seven-year low Nifty dividend yield of 0.8%.

Even more interesting is the fact that over the long term, there seems to be a close correlation between the growth in the dividend payout and the movement in the Nifty. To find this out, we indexed Nifty and the dividend-payout of Nifty stocks, beginning January 1999.

As the chart shows, whenever the Nifty has shot past and stayed above this dividend trend line for a sustained period, a correction has followed. And greater the gap, the sharper has been the ensuing correction. This phenomenon was first observed during the May ’04 correction and then, in May ’06.

Interestingly, just prior to that crash, Nifty had overshot its par value by close to 50%. What is striking, however, is that the Nifty started its recovery the very day the two trend lines converged. Even though the Nifty nearly doubled its value from its June ’06 lows over the next 18 months, dividend payments grew by less than 1/6th the rise in Nifty.

No wonder, the gap between these two trend lines had assumed dangerous proportions by January ’08, with the Nifty overshooting its fair value by over 100%! What followed was for every one to see. What’s even scarier is that the gap between these two trend lines continues to be what the gap was at the beginning of the May ’06 correction!

This means that to close the gap, either the Nifty has to fall by another 25-30% or India Inc’s dividend payout has to grow proportionally. With the latter looking unlikely, we seemed to be destined for an extended, painful and bloody bear market.

Mutual Funds: Cost to investor

The utility that mutual funds can offer to investors has been discussed and often eulogised in great detail. However, there is another vital aspect to mutual funds that is rarely spoken about – the costs. Investing in mutual funds entails bearing certain costs on the investor’s part. These costs, in turn have an impact on the returns clocked by the investor. In this article, we take a closer look at the various costs and expenses borne by investors while investing in a mutual fund scheme.

1. One-time charges
Entry/exit loads and initial issue expenses qualify as one-time charges, as opposed to recurring expenses which have been dealt with later in the article. First, let’s consider the case of new fund offers (NFOs). Over the last few years, investors have been faced with a deluge of NFOs. But in recent times, a perceptible trend in NFOs has been a rise in the number of close-ended funds. This phenomenon can be traced to the rules governing initial issue expenses. Close-ended funds are not permitted to charge any entry load; instead 6% of the sum mobilised during the NFO period can be utilised to meet the initial issue expenses. The same can be amortised (charged to the fund) over the fund’s close-ended tenure.

For example, if a close-ended fund were to mobilise Rs 5 billion (Rs 500 crores) during the NFO period, the asset management company (AMC) can utilise Rs 300 million (Rs 30 crores) to meet the sales, marketing and distribution expenses. Furthermore, the stated sum will be charged to the fund. This will impact the returns clocked by the fund. Any amount over the stated 6% has to be borne by the AMC.

Conversely, in the case of open-ended NFOs, funds are required to meet all the sales, marketing and distribution expenses from the entry load. They are not permitted to charge any initial issue expenses. The rules governing entry/exit loads state that taken together, the two cannot account for more than 6% of the net asset value (NAV). Charging an entry load for the entire 6% upfront would adversely affect the fund’s performance in the initial period. Hence AMCs choose to have rather “rational” entry loads in the range of 2.25%-2.50%. Like initial issue expenses, entry loads also eat into the investor’s returns, since the investor has that much less money working for him.

For example, say an investor invests Rs 5,000 in an open-ended fund that charges an entry load of 2.50%. Effectively, only Rs 4,875 is invested in the fund.

It is not difficult to understand why AMCs have a newfound liking for close-ended funds. With the provision for charging 6% of amount mobilised towards initial issue expenses, AMCs are better equipped to compensate the distributors and agents, who in turn help the fund houses in accumulating more assets. Higher assets translate into higher revenues for the AMCs. Of course, close-ended funds do offer advantages as well. For example, the fund manager can make investments from a long-term perspective and investors are given the opportunity to invest for a pre-defined investment horizon. However, investors would do well to factor in the costs involved.


2. Recurring expenses
Investors also have to contend with recurring expenses, which are charged annually to the fund. These expenses are revealed in the form of an expense ratio that is declared twice a year. Recurring expenses (as is the case with amortised initial issue expenses) are “silent” in nature since they don’t necessarily attract the investor’s attention. The reason being that the fund’s NAV is declared after the recurring expenses have been accounted for.

The Securities and Exchange Board of India (SEBI) has laid out guidelines defining the manner in which recurring expenses can be charged; the same is a factor of the fund’s average weekly assets (however most AMCs choose to compute it as a percentage of the average daily assets).

The expense ratio
Average daily net assets........% Limit

First Rs 1,000 m............2.50%
Next Rs 3,000 m............2.25%
Next Rs 3,000 m............2.00%

On balance assets...........1.75%

As can be seen from the table above, the grid for recurring expenses has been structured in a manner to ensure that the expenses charged to the fund reduce with an increase in the asset size. The recurring expenses include marketing and selling expenses (including agents’ commission), brokerage and transaction costs, custodian fees and fund management expenses (paid to the AMC), among other expenses. A typical list of recurring expenses for an equity fund would look like the following:

Recurring expenses for an equity fund
Expenses.........................% Of average daily net assets
Fund Management..................................................1.25%
Marketing & Selling................................................0.50%
Custodian Fees........................................................0.25%
Investor Communication.......................................0.20%
Registrar Fees..........................................................0.15%
Trustee & Audit Fees..............................................0.15%
Total Recurring Expenses..................................... 2.50%

The expense head which merits attention is “fund management”; this represents the AMC’s revenue stream. In other words, the salaries and other compensation offered to the fund management team is charged to the mutual fund scheme under this head. SEBI guidelines explicitly state the manner for computing fund management charges and limits for the same.

Fund management expenses
Average daily net assets............... Limit
First Rs 1,000 m................................1.25%
On balance assets..............................1.00%

Don't exit SIPs in a falling market

Joydeep Ghosh

Sunil Shah is a worried man today. He entered the market in October 2007, when the Sensex was rising by 1,000 points in a single week.

At that time, his already-invested friends advised him to enter the market through systematic investment plans of mutual funds. Since he had never invested in the markets before, he decided to go the whole hog and started four SIPs of Rs 5,000 each.

In the last eight months, he has invested Rs 160,000. However, the erosion in the net asset value of his mutual funds has meant that the value of his invested money has dropped to Rs 120,000. He does not know if continuing with the SIPs makes any sense now.

"In such cases, investors call up to stop their SIPs or exit them. But, we try to convince them as much as possible to the contrary," says a financial planner. And this Monday, when the Sensex slipped by 506 points, Shah did the same. He called his mutual fund distributor to stop his SIPs.

The distributor told him that it does not make sense to do so as he was getting more units of the same fund for the same money.

"So what? My portfolio is already down 25 per cent. This is like throwing good money after bad money," Shah argued.

His fund advisor explained, "When the NAV falls, you are going to get more units of the fund. That means when the market turns around, you will get much more returns."

Suppose the NAV of a fund is Rs 20. When you invest Rs 5,000 in that fund, the total number of units purchased would be 250 (Without considering 2.25 per cent entry load and an annual 2 per cent fund management charge in equity funds).

However, there is no entry load on investors if they approach the asset management company directly.

Now, if the NAV falls to Rs 18, the number of units that can be purchased is 277.7. A further fall to Rs 15 and the number of units in the kitty is 333.3. Let us take Shah's case. If he were to continue his SIPs, the numbers could look something like this.

Suppose, he accumulated 1,500 units in the first six months at the NAV of Rs 20, another 1110.8 for four months at Rs 18 and another 1333.2 units for another four months at Rs 15, the total number of units he got is 3,944.

If the markets were to turn around in, say, six months and the NAV was to rise to Rs 25, his portfolio would be worth Rs 98,600 (on an investment of Rs 70,000).

And the additional 444 units accumulated during the falling market have added Rs 11,100 to the corpus.

Moral of the story: It's a good idea to continue your SIPs in a falling market.

Patience and strategy lead to good investments

Suresh Sadagopan

If you dig in the same spot long enough, you'll eventually find water, goes an old saying. But many people dig in one place for a while, and then get impatient or distracted and start digging in another place, and then another... When they don't find water in any of those, they blame their luck. It's surprising that more people haven't figured out the simple trick. Of course, there's no denying the importance of choosing the best place to dig in the first place.

Many people dart in a new direction randomly. Many get caught up in the latest investing fads. There are broad trends like equity and mutual fund investing. Then, real estate, commodities, and gold. And then there are micro-trends - read 'fads' - like going overboard on mid-caps, banking stocks, the communications sector, and infrastructure. In pursuit of the latest trend, investors churn their portfolio.

These are the people you find glued to the TV, watching business channels, where post-mortems and predictions are doled out incessantly to viewers who wait with bated breath for the latest, as if they could get the news and act on it before anyone else. But what's on the TV channels is 'news ' only to the retail investor. The rest of the investing world usually not only knows about it, but has often also acted on it. The result is that retail investors are often the last to rush in, and get the empty shell, after the kernel has already been eaten by those higher up in the investing food chain.

The investing topography also has its share of whirlpools and quicksand. These feature things like rumors floated by vested interests, and often aimed at retail investors. Trusting investors follow the trail laid out for them. Then the cowboys who floated the rumours unwind their positions and move on to the next pasture, leaving trapped investors bleating plaintively.

Retail investors are fascinated by day trading. Who hasn't heard a story about someone's neighbor or cousin who makes money hand-over-fist on a daily basis? Isn't it remarkable that one hardly ever hears stories about the losses made by these legends? Many investors have great faith that there exist fail-proof methods to become really rich really quick.

They underestimate the risks they take, and rely too heavily on the instincts of themselves and of others, often at the expense of plain logic. The tide of optimism exposes their gambling streak, and they end up making bets that may not be as sound as they first appeared. Fact is, it's very difficult to predict equity markets, because there are simply too many variables involved

For those who want to get rich fast, investing time frames are measured in days rather than years. All those talk about wealth creation over time - how boring! What could be tamer than returns of 12-15 percent a year? The hot-blooded investor will settle for nothing less than doubling his money in six months. But the fact is that risk and return normally have a direct correlation - the higher the risk, the higher the returns. However, the chances of good returns increase - while risk does not - when one gives one's investment time to perform.

When investors burn their fingers, they leap to the conclusion that investing is dangerous, and swear they will never return to it... until the next fad comes along. Drifting from one investment to another without any strategy will not help anyone reach their long-term goals. It amounts to digging in too many places for water.

If there's no strategy for achieving goals, it may never happen. Many simply chase money. But that money is required for achieving certain milestones, fulfilling aspirations and meeting goals. Making money is fine - who could argue against that! But just chasing money, and letting oneself be led in any direction that seems appropriate at a given moment, will render the whole exercise futile.

Investors need to work with goals in mind, and work towards reaching them in the appropriate time frame, which is what financial planning is all about. There is no compelling reason to arbitrarily gun for some high threshold of return (say 40 percent a year) which will only drive the investors towards riskier options. Responsible investments made over a period help in achieving goals, even if they give modest returns. Investors need to give them time. Like everything else in life, it takes time for an investment to bear fruit.

Less is more. There's no need to keep moving your money around. If you have invested in good options in a diversified manner, just let it be. That way you don't have to constantly look around for options to shift to.
Remember, if something seems too good to be true, it probably is. Schemes which promise stratospheric returns deserve your skepticism.

So do those who claim to be sure about which way the stock market will turn, which stock will do well this year, and the like. When someone is that sure, take their views with a proportionately big pinch of salt.

As for knowing where to dig for water, you would consult a hydrologist, engineer, or some other professional, wouldn't you? Why should it be different with money? Find a consultant you can trust, who will guide you responsibly

5 not to do's in stock market

1. Not to give in to greed and fear: This is an important point, which you, as an investor, must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals. Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back. It is apt to note here what Warren Buffett, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, "It means we miss a lot of very big winners but it also means we have very few big losers.... We're perfectly willing to trade away a big payoff for a certain payoff".
2. Not to time the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers' end. In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again (and will be in 2008). In Benjamin Graham's words, "Basically, price fluctuations have only one significant meaning for the 'true' investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market".

3. Not to act based on rumours and sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investor’s portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffett, "Be fearful when others are greedy and be greedy when others are fearful".

4. Not to attach emotionally with stocks: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price. However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company's performance may improve for the better and the stock would provide an opportunity to exit at higher levels. Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffett's words, "Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks".

5. Not to borrow and buy stocks: This behaviour is typical in times of a bull run when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards). However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements. In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

Systematic Transfer Plans (STPs)

The functioning of STPs is quite similar to that of SIPs in terms of depositing a fixed sum into a fund at regular intervals. The difference here is that a lump sum can be invested in debt funds with nominal risk, and periodically, a specific amount can be transferred to a diversified equity fund.

STPs score over SIPs in a situation where you have the money to invest, but are wary of the turbulence in the market. In such a scenario, it’s better to park your money in debt funds that give decent returns, rather than opting for short-term fixed deposits/savings accounts that earn lacklustre interest. Also, the regular flow of your money into equity funds will ensure that you don’t lose out on the attractive returns they offer.

Ten golden rules of Dalal Street

Dinesh Thakkar

Currently, the Indian markets are in doldrums and nobody is talking of stocks or investments. You may think justifiably so, as the markets are headed in no direction. Is it not exactly the opposite of the exuberant times we were witnessing a few months back. Conversely, bottoms are made in turbulent times.

It is difficult, if not impossible, to say when the markets will halt their southward journey and change direction for the better. Who knows, we might have already hit the bottom and the markets may soon return back to their upward trajectory.

My empirical observation and research have proved it that wealth making in the market has more to do with discipline and the power of time to compound growth than being smart at stock picking and timing the markets just right. To help you in your quest to make wealth in our markets, I suggest you follow the 10 golden rules of markets that will virtually ensure reasonable, steady wealth appreciation.

Bear in mind, you cannot have your cake and eat it too. Saving and consumption do not go hand-in-hand. You need to plan today for the lifestyle you want after you stop working, i.e. the finances you will require after you retire. Accordingly, save the necessary portion of your income to invest in equities. Equities, or stocks, may appear risky, but they are just volatile, they go up and down, and time is the perfect hedge against volatility.

Therefore, Rule No 1: Plan for tomorrow, today. Start saving for it now! Stagger your investments throughout your earning phase. Invest regularly and invest for the long term to buy in at an average price that includes both markets’ up and down ticks.

Never wait until you have large amounts of money to invest. However small the amount you are able to save, start early. The earlier you start, the better are your chances of making great wealth. Remember to make great gains. Time is a crucial factor, as wealth creation is a factor of both the power of compounding and the returns on your investments.

Accordingly, Rule No 2: Start early so that the power of compounding begins sooner; time is the magic that converts paise into rupees. In exuberant phases, when we have earned good money from our investments, most of us get greedy, and derivatives and futures provide an outlet for the expression of human greed. While such instruments often satisfy the whims of human greed, if taken to unrealistic levels, irresponsible investment in these securities can lead to financial ruin.

Hence, Rule No 3: Do not leverage, it is difficult, if not impossible, to predict short-term trends. Buy markets, not stocks. We all know that our economy is in a secular phase of rosperity and the stock market is the best proxy for the growth of an economy. To benefit from our oaring economy, buy the market as a whole and not any single stock.

Consequently, Rule No 4: Buy stocks that mirror the broader indexes, but never buy a single, or a handful of stock exposures. This means that you need to spread your risk across various market segments in the event a particular stock does not perform for reasons beyond the company’s control. It is easier to predict company earnings, but difficult to predict stock prices of the same company in the short run. Ironically, over the long term, stock prices mirror growth in a corporation’s earnings.

Therefore, Rule No 5: Look at company earnings, not at stock prices. Stock prices may tempt or give the wrong impression of a company’s welfare. But to build real wealth in equities, you must always rely on declared profits and facts, rather than make decisions based on stock movements. We all tend to sell stocks when we have made profits and keep the ones that have not appreciated. Eventually, we end up holding a portfolio of companies that are not performing! It is only human to sell for profits and not to want to take losses.

Hence, Rule No 6: Keep the winners, sell the losers. Stay on top of your investments. Check constantly for stocks that are not performing and eliminate them from your portfolio if the outlook does not seem promising. This way, you will have all winners left in your portfolio to take you to your goals.

In exuberant times, we all tend to believe that the good times will last longer than they actually will. And before D-day, we will be able to sell our investments that were bought at unjustified levels. Just then, it happens that the markets turn and before we can sell out, we are left holding the bag.

For this reason, Rule No 7: Avoid being the “Bigger Fool;” it is imperative that you recognise the difference between price and value. Buy value and not momentum. When investing in stocks, your head should prevail over your heart. Resist the urge to get consumed by market chatter. Ignore hot tips from dealers and friends. It is advisable to do your own home work.

As the result, Rule No 8: Pick stocks with your brain, not your heart. Large-caps are the ones that have already proven themselves over longer periods of time and have the balance sheet acumen, strong cash flow and brains to manage businesses effectively according to prevailing situations and realistic opportunities available.

Hence, Rule No 9: Prefer large-cap stocks to small- and medium-caps. Investment in small and mid-cap stocks requires expertise and strong tracking abilities, that without, your portfolio will under-perform. Do not short sell a stock just because it is going up, and thus, one day it must come down. Newton’s law is not applicable to the markets. What goes up does not necessarily come back down! If companies are able to sustain earnings’ growth for long periods, then its stock may go up, up and up, or it can even remain high without any reason for a long period of time.

Because of this, Rule No 10: Markets can remain irrationally up, or continually climb for the right reasons. Therefore, never go short. It will expose you to unnecessary risks.

Investing & the theory of inversion

"66", muttered the grocer to himself as he reached out to his cash counter at one of the corner grocery stores and pulled out few notes and coins totaling Rs 66. He settled the transaction by promptly handing over the money to the customer who had bought goods worth Rs 34 but had paid Rs 100 for lack of change.

While the grocer moved onto other activity with nonchalant ease, we were impressed by how quickly he managed to mentally calculate the difference between 100 and 34. After watching him settle few more of such transactions, it finally dawned that rather than subtraction, he relied upon a quicker and a less error prone technique of starting with the base amount and then continuing adding to it until he reached the amount that the customer actually paid him. Like in the case of the customer who gave him Rs 100, he started with 34 and kept on adding until he reached 100. '66', the number struck to us at lightening speed and we had just discovered a technique that is sure to save us few hours over the course of our lifetimes.

Little did the grocer realize that he was relying upon a mental exercise that the famous mathematician Carl Jacobi had made immortal with his words, "Invert, always invert". Jacobi had reasoned that it is probably in the nature of things that a lot of problems in the world can be solved by thinking backwards. This phrase has been made more famous in recent times by Charles Munger, the lesser known but an equally erudite partner of Warren Buffett and who is believed to have had one of the greatest influences on him.

Let us try and find answers to few simple questions like 'What does it take to be successful?' or 'What should I eat to remain healthy?' While the answers to these questions can definitely be worked out, exactly opposite queries to the above set of questions will most likely lead to new insights and make our job that much more easier. Thus, if we now try answering questions like 'What qualities makes a man unsuccessful and how should I avoid them?' or 'What food will make me fat and unhealthy?' These questions are exactly opposite in nature to the ones posted above and rely upon the theory of inversion. To test the efficacy of the method, additional sets of questions, one proper and one inverted should be framed and indeed analysed. After going through the results, we don't think that there would be doubt in anyone's mind that this technique is indeed a very important tool to solve many of the life's problems.

Now, how do we use this theory of inversion in the field of investing? We believe that inversion works just as fine in investing as any other field and if properly adhered to, is likely to result into much better investment results. Say for example, after an investor has carefully analysed all the reasons for investing in a stock, he should resort to inversion and ask himself, "What are the reasons that will make me not invest in the stock?" More often than not he is likely to stumble upon something he had not known previously and hence, would help him take a more informed decision.

Another way in which the technique can be used effectively is by questioning the price that a stock commands in the market place. Normally, while analyzing the investment worthiness of a stock, an investor makes some assumptions about future cash flows and discount rates and then arrives at a fair value. This fair value is in turn compared with the stock price and depending upon the premium or discount, one chooses to invest or not to invest in the stock. How about inverting the analysis and starting with the market price and then questioning ' What kind of future cash flows does the current market price imply?' The results that such kind of analysis throws will be no less than startling.

Let us consider a company ABB, which as per our database is currently the most expensive stock on the Nifty with a trailing twelve-month price to earnings ratio of 50 times. Now if you are the one looking to invest in 5 baggers with an investment horizon of five years then is the stock a right bet for you? Let us assume that in five years time, the stock will come down to a more realistic and the broader market like P/E of 20 times. Thus, for the stock to become a five bagger in five years, it will have to grow its earnings at a CAGR of around 66% (explanation given below), a feat that is really difficult if not impossible to achieve for most of the well-established companies like ABB.

This wonderful insight was made possible because of inversion. We started with the price and the P/E ratio and then went on to check whether it is really possible for the stock to become a five bagger, realising that the probability of such an event happening is indeed low. Hence, the next time you come across a good stock to consider for investment, do not forget to pass it under the screen of the inversion theory and as mentioned before, the results might surprise you.

Explanation - Assume that ABB's current EPS is Re 1. So, at 50 times P/E, the company's current stock price will be Rs 50. If the stock were to become a five bagger in five years, the price has to touch Rs 250. Now, assuming that after 5 years, the stock's P/E were to come down to a more realistic and the broader market like P/E of 20 times, the EPS thus calculated will be Rs 12.5 (Rs 250 divided by 20). Compared to the current assumed EPS of Re 1, for the same to grow to Rs 12.5 in five years times would require it to grow by 66% CAGR.

The right track

Index funds track the broad market, and thus make for a good investment in a rising market—but watch out for the tracking error.
Narendra Nathan
6 Jul 2001

SEASONED INVESTORS know that the best time to buy is when everyone else is selling. Which should make it a good time to invest in equities now. That, however, has its own associated difficulties—stock-picking is not easy.

There is, however, a special class of mutual funds—index funds—that are designed to track the market's every move. That makes them an attractive investment in a market recovering from a bear run.

No fund-manager risk. Mutual funds have historically offered lower returns than the broader market. That is because fund managers, in their attempts to beat the market, often go overboard and deviate from their mandates. LIC’s Dhanasamrudhi Fund, for instance, has a portfolio that is heavily skewed in favour of just four stocks: ITC (37 per cent), Hind. Lever (27 per cent), Bharat Petroleum (18 per cent) and Sterlite (17 per cent). Others are heavily concentrated on just one sector. For instance, ING Growth Fund is biased in favour of ICE (Information, communication and entertainment) stocks, which constitute 92 per cent of its portfolio. Not surprisingly, the fund’s NAV has fallen 67 per cent as compared to the broad market’s fall of 28 per cent.

Managers of index funds, on the other hand, have a simple mandate—to closely track a chosen index. That precludes any attempts to beat the market, and therefore the low returns that most mutual funds are prone to. It also makes for a well-diversified and balanced portfolio. The table below details the four index funds available in India.

Beware of tracking error. Theoretically, returns from index funds should not deviate at all from the indices they are based on. In practice, however, there is a slight variance, known as the tracking error.

For an illustration, take the returns from a fund based on the Sensex. Rs 100 invested in a Sensex index fund (on 1 April, when the index was launched) should now be worth Rs 3,457. This works out to a reasonable long-term return of 17.15 per cent per annum. A tracking error of 1 per cent would mean that returns from this fund would vary from the Sensex by 1 percentage point on an yearly basis. If that 1 percentage point tracking error is on the negative side (that is, the fund’s returns have lagged the Sensex by 1 percentage point year-on-year), the index fund would have grown at 16.15 per cent since its launch. The Rs 100 investment would now be worth Rs 2,867—a gap of Rs 590. So, the lower the tracking error, the better the index fund.

Index funds in India typically have higher tracking errors than the ones in developed markets. For instance, the tracking error of UTI Nifty Index Fund exceeds 5 per cent—that’s more than 10 times the average figure for index funds in developed markets.

Causes of tracking errorExpenses. Expenses are the biggest cause of tracking error. Fund’s expenses include asset management fees, agents’ commissions, brokerage on buying and selling of shares and stationery expenses. Index funds in developed markets have very low expenses, thus reducing their tracking errors. By contrast, the best index fund in India, IDBI Principal Index Fund, has a tracking error of 0.74 per cent. The figure is even higher for the two index funds managed by UTI, as it charges expenses at the highest level allowed by Sebi. Explains Nilesh Shah, the fund manager, "We have to spend a lot of time and money to educate investors—what an index fund is, what can be expected from them…"

A closer look reveals that the major constituent of the expenses is the asset management fee—all the four available funds charge expenses at the highest permitted levels. (Two of these funds charge 1.25 per cent, the maximum allowed for funds of a size below Rs 100 crore.)

That seems unreasonable, as there is no active trading or stock selection involved—after all an index fund merely tracks the index. Rajat Jain, chief investment officer, IDBI Principal, counters this: "Even though there is no active trading, we still have to manage the funds and we have one person dedicated for this fund." Nilesh Shah, for his part explains: "We have forced to charge the maximum possible AMC fee because of the small corpus. Once the corpus improves, the AMC fee will come down."

Lack of competition is probably the biggest reason index funds charge the maximum allowed fund management fees. As more fund houses enter the fray, these fees should fall.

Dividends. Most index committees do not factor in the dividends declared by companies while computing the index. For instance, the dividend yield of Sensex and Nifty stocks is around 1.5 per cent, but this is not considered in the index calculations. An index fund’s NAV would rise when it receives dividend, and this would introduce a positive tracking error (which is a good thing, as opposed to a negative tracking error). The argument is that dividends represent a very small fraction of a fund’s corpus, and so are not worth the trouble.

The index committee at the NSE (National Stock Exchange) is now working on the Total Return Nifty (inclusive of the dividend), which would be used as the benchmark to compute the tracking error. Such a reworked index is not available for the UTI Master Index Fund, the only fund tracking the index.

Trading expenses. Tracking error is the difference between a fund’s NAV and the index’s closing price on any given day. Both the NAV and the index are calculated at the end of each trading day, based on the closing prices of stocks. However, funds have to do their buying and selling throughout the day, and their prices may vary from the closing prices.

The NSE’s post-closing session enables funds to buy and sell at the closing price, thus eliminating one constituent of the tracking error.

Market lots. Assume that an index fund receives an inflow of Rs 5 lakh in a day. This can’t be parked on the same proportion on the same day, as the exact division will leads to investment in shares in fractions, which is not possible. The allotment has to be rounded off to the nearest whole number, which introduces another element of tracking error. This problem used to be even more severe before the introduction of dematerialisation, when stocks had to be traded in market lots of 50 or 100 shares.

Index futures have helped funds reduce this element of tracking error. Explains Rajat Jain, chief investment officer, IDBI Principal, "What we can do now is park these small (residual) amounts in index futures and convert them into actual shares on a later day."

Cash component. Being open-ended, index funds have to keep a fraction of their corpus ready in the form of cash. This cash component adds to tracking error. For illustration, assume an index fund with 4 per cent of its corpus in cash. If the index rises by 5 per cent, this fund’s NAV can rise only by 4.8 per cent. The tracking error will be directly proportional to the cash component of an index fund.

Frequent trading by punters. Index funds are usually favoured by long-term investors, but punters often trade in and out to profit from short-term fluctuations. Frequent trades increase transaction costs, thereby increasing the tracking error.

All index funds have entry and exit loads to deter frequent trading. IDBI Principal charges an entry load of one per cent. UTI and Templeton funds do not charge entry loads, but have an exit load of one per cent for withdrawals before six months from the date of entry.

How is tracking error measured?The tracking error is the difference between the return generated by an index fund and those by the index it is based on. Assuming that the return generated by an index fund on a given day is 5 per cent and that by the underlying index is 5.13 per cent, the fund’s tracking error for that day would be 0.13 per cent. These errors are squared and added up for the last one year; the square root of this sum is the tracking error value for the full year. Another way to arrive at the tracking error is to calculate the standard deviation of the daily errors. This standard deviation is then annualised by multiplying it by the square root of 250 (on the assumption that there are 250 trading days a year)

SIP or ....

Vivek Kaul

With the stock market down from its recent highs, one comes across a lot of half-baked analysis suggesting one-time investing is better than systematic investment plans (SIPs).

The primary reason for this may be the newspaper editors' craving for sensational headlines. Surely, "One time investment better than SIPs" makes for a much sexier headline than say "Continue with your SIPs." But, that doesn't quite make a good investment strategy any bad, or vice versa.

Let us consider four schemes, which have done very well over the last three years — Sundaram BNP Paribas Select Focus, SBI Magnum Contra, Kotak Opportunities and DSP Merrill Lynch India Tiger Fund.

Had you had started an SIP of Rs 5,000 every month in any of these schemes around three years back, you would have invested Rs 1.8 lakh (Rs 5,000 x 36 months) by now. You would have managed to accumulate around Rs 2.8 lakh by now, at an annual rate of return of around 30%.

Instead if you had invested Rs 1.8 lakh into any of the schemes on April 1, 2005, i.e. around three years back, your corpus would be anywhere between Rs 4.83 lakh and Rs 5.2 lakh depending on the scheme chosen.

Now, consider a situation where an investor started an SIP in any one of these schemes around one year back. An investment of Rs 5,000 per month would mean he would have invested Rs 60,000 over the year.

Now, in 2 out of the 4 schemes, he would have lost money. In comparison, had he made a one-time investment in any one of these four schemes, the value of his Rs 60,000 would be anywhere between Rs 80,000 and Rs 84,400.

Clearly, over both three-year and one-year periods, one-time investments would have worked better than SIPs. So why are we suggesting that SIP is the better option?
Let us sample the reasons.

First, you would agree that an individual has a better chance of investing Rs 5,000 every month, compared with putting in Rs 1.8 lakh at once.

Second, the SIP investor has also earned a return of around 30% per year and that is not bad by any stretch of imagination when compared with other modes of investment in the market.
Third, one-time investing works very well when the market is on its way up, as it was for the last three years, until the slide began. Thus, all the news highlighting the better performance of one-time investment vis-à-vis SIPs has the benefit of hindsight.

Now, let us take two investors, one of whom invested Rs 60,000 and the other Rs 1.8 lakh on January 8, 2008, when the stock market peaked. The investment of Rs 60,000 in any of these schemes would currently be valued anywhere between Rs 39,000 and Rs 43,000 a loss of around 33%.

Similarly, Rs 1.8 lakh invested in any of these schemes would currently be valued anywhere between Rs 1.19 lakh and Rs 1.24 lakh.

Now tell me, who would be better off? An investor who puts in Rs 5,000 every month over a period of one year or three years, or one who invested Rs 60,000 or Rs 1.8 lakh at one go, on the day the market peaked?

To reiterate, one-time investing works very well when the markets are going up. But, does anyone really know how long they will keep going up, or for that matter, whether they will from a certain point? Nobody does, for sure.

This is why it makes sense to keep investing in mutual funds regularly through the SIP route.
SIPs also help the investor buy more units in a falling market and thus decrease the overall cost of purchase of each unit, a phenomenon known as rupee cost averaging. Needless to say, that benefit is not available to the one-time investor.

How to avoid getting clean bowled by inflation

When Kapil Dev won the World Cup in 1983, the price of a bottle of soft drink was about Rs 1.75. When MS Dhoni won the Twenty-20 World Championship in 2007, the same soft drink cost about Rs 11. That’s a staggering 8% rise in price on an annual basis. The product is no different over these 24 years — the soft drink tastes the same.

So, what happened? In a hidden way inflation has been getting us out regularly and we have done nothing to defend ourselves. Inflation is the worst kind of tax that each one of us pays. Sustained inflation will make all of us poorer in the long run. So, it’s worth understanding how we can offset the impact of inflation.

But first, let’s quickly understand what inflation does to our daily consumption and our long-term savings. Hurts consumption & savings The government regularly releases a statistic called Wholesale Price Index (WPI), which is supposed to measure the general level of prices in the economy, based on a collection of goods and services that we consume. The figures released last week show that WPI had risen by 7%, i.e., prices were 7% higher than they were the same time last year. But, when we as customers go out to buy vegetables or get an airline ticket or have a haircut, we actually pay much more than the 7% increase WPI claims — everything seems to be costing more than what official statistics would suggest. Higher food and petrol costs result in lesser money in our pockets after meeting all our necessary expenditures. This cuts into our ability to spend on non-essential items such as watching a new movie or buying the latest cell phone. Thus, our standard of living suffers today.

Sustained inflation will continue to cause our standard of living to suffer and prevent us from accumulating wealth, especially if our savings and investments are not protected against inflation. In an environment where inflation is 7%, the first 7% of returns that our savings earn, will offset the negative effect of inflation, leaving us where we started. Just to maintain our present purchasing power, i.e., our ability to continue to afford goods and services in the future that we enjoy today, we need our savings to at least earn a return that equals inflation.

For our wealth to increase, we need returns much higher than inflation. Let’s look at an example. Say you have saved Rs 100,000 in fixed deposits maturing a year from now. Such a deposit typically earns a 10% rate of interest, which will give earn you interest income of Rs 10,000 at the end of one year. However, this is before you pay income on this. Assuming that you are in a lower tax bracket of 20%, you will pay a tax of Rs 2,000, leaving you with only Rs 8,000, an 8% aftertax returns. At a time when inflation is 7%, the first 7% of the after-tax 8% return will basically offset this price rise. Your real wealth increases only by 1%. At this rate, it will take over 70 years to double your real wealth. If inflation goes to say 8%, you will never see an increase in your wealth, on the contrary you will be much poorer in the long run. In a fast growing economy like India, we will likely experience inflation on the higher side. The economic impact of 7% inflation is the same as increasing our income tax by 7% — it would reduce our purchasing power and leave us with less money. Will we accept a 7% rise in income taxes quietly? No. So, why should we not act to offset the impact of inflation?

If you don’t want to be poorer or sacrifice your long-term standard of living, consider the following ways of dealing with inflation.

How to manage your consumption

Food
Buy non-perishable food items in bulk to get bulk discounts
Use promotional coupons and loyalty discounts
Don’t shy away from shopping at the larger format grocery stores, you will likely get better prices than at the local neighbourhood grocer
Regulate how frequently you eat out — if you cannot avoid it, try happy hours when prices are discounted
When ordering a takeaway, use discount coupons like “buy one, get one half price”.

Energy and Petrol
Avoid driving in large cars that consume more petrol
Use public transport where convenient or join car pools
When going on a vacation choose a mode of transport that is cheaper — take low-cost airlines or be flexible on the time/date you want to fly to get cheaper fares or take trains to avoid the high-fuel surcharges that airlines are charging
Take steps to reduce your electricity bill — be disciplined about turning off lights and buy gadgets that are power efficient.

Bills and Credit Cards
Pay your bills on time to avoid late penalties
Always look for cheaper pricing plans. For instance, is your current mobile plan the cheapest — new cheaper pricing plans get launched almost monthly, take advantage of these plans Do not spend on credit cards, use a debit card where possible. Late payments on credit card fees will clean bowl you every time.
Discretionary Spending Reduce avoidable expenditures — is that latest fashion accessory really necessary? If you must buy, do comparison shopping or wait for seasonal discounts during the festivals.

How to manage your savings
Choose higher returning and tax-efficient investment options Don’t shy away from Equities — long-term returns can be expected to be at least 12%. Assuming that zero-capital gains on long-term equity holdings continue, returns will be better protected against inflation compared with fixed deposits
Reduce allocation towards bonds and fixed income — inflation will cause a vicious reduction in your purchasing power if you are heavily invested in fixed income instruments; additionally, the tax treatment of many such instruments is less favourable than that of equities.

Consider alternative assets
Real estate — generally speaking, the value of a real estate asset will hold up better than other assets. Also, if you are deriving rental income from property, you can exercise your ability to raise the rent you charge.
Gold — traditionally,gold has been a safe haven against inflation due to expected appreciation in gold price at times of high inflation, but you will get no income from this asset
Art — if you can afford it, certain types of artistic creations will not only preserve their value over time, but in fact, the increase in their value can outpace inflation.

The worst thing is inertia — do not just save your money in a savings account. You are almost certain to lose your purchasing power and face a decrease in your real wealth. This is a bigger risk than putting money in the equity market. We cannot predict when India will win another major cricket trophy, but we can be sure that inflation will continue to affect us. Let’s hope that by the time India wins another tournament, you and your savings will have been well protected against inflation so that you do not get clean bowled later in life. (Authors are co-founders of iTrust, a financial advisory and wealth management firm .)

Value investing pays

Vivek Kaul

Among the many speeches the sage of Omaha, Warren Buffett, has delivered over the years, his most significant speech is ‘The Superinvestors of Graham and Doddsville’, delivered to the students of Columbia Business School, in 1984, at a seminar marking the 50th anniversary of the publication of Benjamin Graham and David Dodd’s all-time classic Security Analysis.

Warren Buffett was a student of Graham and has over the years remained committed to the philosophy of ‘value investing’ put forward by Graham.

In that 1984 speech, Buffett said, “The common intellectual theme of the investors from Graham and Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.”

The stock markets are not efficient, i.e. the price of a stock does not reflect everything that is known about a company or the economy. Given this, there are stocks which sell at a price less than what they deserve.

So, the only thing a value investor is bothered about is the worth of the business. “He’s not looking at quarterly earnings projections, he’s not looking at next year’s earnings, he’s not thinking about what day of the week it is, he doesn’t care what investment research from any place says, he’s not interested in price momentum, volume or anything.

He’s simply asking: What is the business worth?” said Buffett. “While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock.” Understandably, the time of entry into a stock is not important for a value investor.

“He doesn’t worry about whether it’s January, he doesn’t worry about whether it’s Monday, he doesn’t worry about whether it’s an election year. He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me,” said Buffett.

Passive investing helps

Vivek Kaul

If this year has been bad for the stock markets, it has been worse for mutual funds. Mutual fund net asset values (NAVs) have fallen much greater than the broader market.

Even those investing for 2-3 years have seen a substantial fall in the values of their portfolios. Fund managers who seemed to do no wrong until a few months back, are now an embarrassed lot. Even over longer periods, there is little evidence that active investing works.

As Peter L Bernstein writes in Capital Ideas Evolving, “In 2004, Burton Malkiel of Princeton, and author of A Random Walk Down Wall Street, studied all mutual funds in existence since 1970 — a total of 139 funds surviving over more than thirty years.
He found that 76 of the funds underperformed the market by more than one percentage point a year; only four funds outperformed by more than two percentage points a year. Malkiel reports that more than 80% of the actively managed large capitalisation funds covered in the Lipper Analytical Services failed to match the returns of S&P 500 over periods longer than 10 years ending in 2003. Malkiel also points out that “there’s almost no persistence in excess performance… In decade after decade, the top funds in one period are often the bottom funds in the next… There’s no way to tell in advance which funds will outperform.””

So, the five star funds of today may not be the best performing funds of tomorrow. Take the Sundaram Select Midcap Fund, which was the darling of investors till about a year back. The scheme has given a return of 15.78%, against the category average of 20.745%. The fund managers were clearly not able to manage the deluge of new money into the scheme.

So, the best option for investors is to invest in index funds — mutual fund that index stocks in the same proportion as their proportion in the index. But, often fund managers are guilty of trying to actively manage these funds. In this situation, it makes sense to invest in the few exchange traded funds currently available.

8 key ratios for picking good stocks

The following 8 financial ratios offer terrific insights into the financial health of a company -- and the prospects for a rise in its share price.

1. Ploughback and reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.

2. Book value per share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.

3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.

4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.

5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.

6. Return on Capital Employed (ROCE), and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.

8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.

[Excerpt from Profitable Investment in Shares: A Beginner's Guide by S S Grewal and Navjot Grewal.]

Seven things to remember in bear run

The year 2008 has been unkind to investors so far. Many have suffered huge losses. Who knows, there could be more pain ahead. It’s worth reminding ourselves of basic lessons that every retail investor ought to keep in mind to avoid, or at least minimise, losses in one’s portfolio.

1. High rewards don’t come without taking high risk.
During a bull market, retail investors get taken in by the rise in the stock market. They don’t want to be left out. So, they rush in and buy in an indiscriminate way, without realising that they might be taking on too much risk. Remember, if you chase high returns, high risk will follow you. Let’s take the example of publicly-listed real estate sector in India. The industry has a very favourable long-term future. However, the rapid rise in the sector’s stock prices over the past year made a short-term investment in these stocks a risky bet. As it turns out, the risks have been borne out and this sector has collapsed spectacularly. Understand your own risk profile and how you emotionally deal with volatility in stock prices.

2. Understand what you own — don’t always rely on the latest tip or prediction.
If you knew the secret location to some buried treasure, would you share it with others around you? If someone really has a hot tip on an investment that is going to earn high returns, always ask why they are sharing it with you. In today’s wired world, it is possible even for retail investors to understand, even if in basic ways, what is it that you are about to invest in — what does the company do, who its customers are, is the company profitable and so on. You must form your own view about the company’s prospects. Stay away from fast risers. The more you understand investments that you have made, the more confident you will become.

3. Leverage is a double-edged sword that can destroy you in falling markets.
The recent collapse of various hedge funds and banks has shown that living on borrowed money can be dangerous. During good times, leverage can amplify your returns. But in rough times, it can kill you. Currently, even the world’s best risk managers on Wall Street are having a tough time dealing with their leveraged exposure to markets. Be careful about making investments using leverage. Remember, nobody is going to flash an emergency light announcing the arrival of the next crisis.

4. Keep some of your powder dry — you don’t always need to be fully invested.
This is where the professionals really distinguish themselves from amateur retail investors, because they keep some cash available to take advantage of falling prices. Professionals think of a correction in stock prices as a sale in stocks. But to benefit from these sales, they keep some cash ready. They don’t feel the need to be fully invested all the time. If you use up all your cash to make your investments, you will never be able to take advantage of the cut price sales that will happen in times of severe correction like now. Corrections occur periodically — be prepared to take advantage of these situations.

5. Build portfolio on a strong foundation.
Just like you cannot build a house on a weak foundation, your stock portfolio also needs to be built on the back of strong companies and predictable stability. The more junk you have and poor quality stocks you own, the quicker your portfolio will also collapse during a correction. Weak companies with unfavourable long-term business prospects, weak balance sheets and poor operating performance might look tempting as they promise short-term growth. They may go up faster than the market in a bull phase, but come racing down at the slightest evidence of any stock market trouble.Build your portfolio on the back of stable, blue-chip companies that have long track records of success across economic conditions.

6. Keep a wishlist of companies.
Smart investors keep a wishlist of companies whose shares they want to buy when the opportunity and price are right. Corrections will give you the opportunity to pick through names. But, like we said in point 4 above, you need to have some dry powder to be able to add your wishlist to your portfolio. Warren Buffett has been known to keep his eye on his wishlist companies for decades before he finally finds a good entry point for an investment.

7. Invest for the long-term.
Serious investors put money to work for the long-term. They don’t get distracted by seasonal or cyclical fads, or get caught up in short-term performance. Don’t day trade, and especially not on margin. For every day trader who wins, there is another trader on the other side of the trade who has lost. In this speculative game, its likely that you will on average have as many bad days as good days. If you invest for the long-term, you will be less affected by all the noise in the market that will clutter your thinking and cause you to make impulsive and short-sighted decisions. You will also avoid the tax liability associated with short-term trading that can add more complexity to your finances.

It is never too late for serious investors who want to build long-term wealth to learn and apply the above lessons. With a little bit of discipline, your portfolio too can survive any stock market correction and achieve excellent long-term performance.

Mid Cap Funds: For the long-term

The recent stock market crash has been particularly harsh on one investment category – mid cap stocks/funds. Compared to their large cap peers, mid cap stocks/funds have fallen more sharply. The view that many frustrated investors might take is that investing in mid caps was a bad idea in the first place. And they can’t really be blamed, in many ways mid caps were presented as an opportunity to make quick money without informing the investor of the higher risk involved.

At Personalfn, we have a different view on mid caps. There is no doubt that if identified correctly, mid caps can contribute significantly to an investor’s wealth. For investors, there is merit in including mid cap stocks/funds in their portfolios; the allocations will vary depending on their risk appetites (aggressive investors can invest larger amounts in mid caps). Of course the higher gains in mid caps don’t come easy; investors have to brace themselves for higher volatility as well. For various reasons like evolving systems and corporate governance (vis-à-vis the large caps) the mid cap segment is prone to uncertainty. This explains why mid cap stocks/funds usually bear the brunt of stock market volatility. If anyone needed proof of that, the latest market crash provides it in adequate measure.

The biggest losers in 2008 have been mid cap funds (as also thematic funds with higher allocations to mid caps). That is not surprising because when markets hit the panic button, generally stocks with the highest risk get dumped first. And mid caps carry higher risk than large caps. Since systems and corporate governance are still evolving in most mid caps, investors may overlook some of these critical issues during a market rally. However, when markets are volatile, nervous investors consider these issues in a new light and are quick to abandon mid caps if there is any uncertainty. To that end, large caps given their stable fundamentals (like profitability and sales) and systems are evaluated differently and even when they are abandoned in times of nervousness, at least they are not the first ones to be dumped; that ignominy is reserved for mid caps.

Unfortunately, even investors who have a long-term view on mid caps find it difficult to deal with the extreme volatility. There are doubts about whether mid caps are worth it at all and if markets are in a freefall how long should they remain invested.

To answer these questions, it’s important to revisit some points about mid caps:

a) Not all mid caps prove to be worthy investments, even if they are held onto for the long-term. For every HDFC Bank that began as a mid cap to blossom into a large cap, there is a Global Trust Bank that nearly went bust. As a lay investor what are your chances of identifying the right mid cap stock? Not very bright, which is why a professional fund manager is a good bet to identify the best mid caps. Fund managers are more likely to identify the reasons ‘not to invest’ in mid caps and in this way considerably lower the risk of investing in mid caps.

b) The other way to reduce the risk, after having identified a ‘sound’ mid cap investment is to always have a long investment time frame (for mid caps we recommend at least 5 years). As a reputed fund manager observed – equities are the least risky asset over the long-term and the riskiest assets over the short-term. So if you have taken the mid cap route to generate wealth be prepared for the long haul. This way you will be relatively unaffected by intermittent volatility because you are clear that you expect to remain invested for at least 5 years (which we recommend strongly to our clients).

Over the last 5 years (which is when the mid cap rally began picking up steam) mid caps have performed relatively well compared to large caps. Over the last five years, Rs 100 invested in the CNX Mid Cap would have yielded Rs 624 compared to the Rs 473 that the BSE Sensex would have yielded. This gives investors an idea about how mid caps can help their money grow relative to large caps. However, mid caps have also lost more money for investors over certain time frames; a case in point is the present market decline, which has hit mid caps harder than large caps (refer to the graph for the more pronounced dip in the CNX Mid Cap index over the last few months compared to the BSE Sensex).

Lessons for investors

1) Mid caps, as we have seen, can prove very rewarding over the long-term, but that is no green signal to go overboard on mid caps.

2) Invest in mid caps in line with your risk profile. If you have appetite for high risk then you can invest higher in mid caps (your financial planner can recommend a mid cap allocation that is suitable to you). On the other hand, investors with moderate risk appetite can invest smaller amounts. The present market crash is an easy way to determine your risk appetite. If the sharp decline in mid caps has left you a very worried investor, then your risk appetite is perhaps not as high as you had previously imagined. This is a signal for you to tone down your mid cap investments.

3) Regardless of your risk appetite and mid cap allocation, you must be prepared to remain invested in mid caps for the long haul. That is the only way you will be relatively indifferent to intermittent volatility in that segment.