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.