Deep Truth about the Markets and Investing

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

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

Good stocks can go down for no reason.

Bad stocks can go up for no reason.

A trend can last much longer than you thought possible.

Stocks don’t know you own them.

The market doesn’t care about politics.

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

Mega-mergers rarely work.

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

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

Commodities are almost always terrible investments.

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

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

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

Wherever possible, seek out stocks with expanding margins.

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

Portfolio diversity is overrated.

As a general rule, IPOs are a bad deal.

Boring but profitable always beats exciting and unprofitable.

CAPM and MPT are nonsense.

No one can consistently time the market. No one.

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

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

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

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

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

Follow unfollowed stocks.

The market is self-aware. Scary but true.

It’s far easier to rationalize selling than buying.

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

But it’s very, very, very, very hard.

Most technical analysis is complete garbage.

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

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

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

Except at very low levels, volatility is neutral.

Many gold bugs are quite simply fanatics.

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

Never base an investment decision of demographics.

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

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

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

Start investing early, stay with SIP through thick and thin

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

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

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

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

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


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

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

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

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

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

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

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

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

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

The one quality that sets investors apart

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

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

Investors must avoid enthusiasm

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

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

Patience

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

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

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