Investment idea- Tips when Markets fall

     

     

                            Tips for investors when markets fall

NEVER forget that what goes up, must come down.

            This is the cornerstone of a successful and contented life. A sudden rise in the stock indices may have you smiling from ear to ear. It's the slide that tests your real strength.

1.     Forget about rationalizing and explaining (or listening to other people explain) why stocks are falling. It's a pointless exercise.

2.     Markets will go up and go down -- you cannot change that. You can change the way you look at it. When you have money you will invest, when you need money you will sell. There is no call to action based on 'what the market will do'.  So that does not matter.

How to avoid the mistakes 

1.       Contrary to popular belief, stocks are long-term wealth creation instruments. But, most of the people use them as short term instruments to make quick bucks and when the tide turns against them, they swear never to look at equities again. Some people religiously follow each and every piece of investment wisdom available through TV, print media and believe activity is the name of the game. Investing in the stock markets on the contrary is not a game or a contest; it is a continuous process over one’s lifetime.

                2.     For your peace of mind and prosperity, do not leverage or borrow to invest. Understand the risks associated with it and only bite what you can chew and digest comfortably.

           3.    I often come across ads which state, “Invest only Rs. 50000 and earn Rs. 5 Lakh, Intra Future Short Term Tips” to tips such as “Ye Stock 3 Months main Double hone wala hai”. In bull markets you will come across plenty of such nonsense, which you can comfortably ignore.

          4.    Timing the markets is one elusive strategy yet millions of people aim to do it and many claim to have done it. Whether it’s the technical analysis or the fundamental analysis or a combination of both, getting your entry and exit right is the most difficult to achieve. So don’t fret whether you are investing at the highest level or lowest level, just do it systematically every year.

          5.      Everyone likes to talk about their success but very few people like to talk about failures or even admit them. Overconfidence and pessimism are two sides of the same coin. First four months of 2006 saw a lot of overconfidence only to be followed by many months of pessimism. The stock market will make even the most adventurous person humble and you would excel in investing by understanding this reality. 

Action Items for evading mistakes:

a.      Make a New Year resolution to first and foremost spend some time thinking about your future goals and writing them down on paper. Writing your goals on paper has the power of making them a reality. Thinking would certainly take you one step closer to rationality, which is an important ingredient in the world of investing.

b.       Do a Financial Fitness Checkup by looking at your overall asset allocation, products, time horizon, return objectives and risk tolerance.

c.       Finally Prepare an Investment Policy that will form the basis for your buy and sell decisions. The purpose of a written plan or a policy is to help you prevent costly mistakes, help you achieve your goals in life, providing comforts during very stressful moments while at the same time enjoying your journey called life.
 An article published in Fortune Magazine described a study that found investors who made written plans by the time they were 40 wound up on an average with five times as much money by age 65 as against those who didn't have written plans.
 A wise man said, “The best time to buy stocks was Yesterday. The second best time is NOW”. View corrections in the market as great buying opportunities. 

 

 

How to make hay when the market crashes

 

Most people have entered panic mode. Those who are long on futures and holding call options have had their wealth wiped out, instantly. But it is important to understand that we have a similar scenario every time there is a correction.

I always warn people that the markets can be very lethal if you enter without proper knowledge. But powered with knowledge, market corrections and falls are a great opportunity to create wealth.

You can rise in the fall!

A 1,400-point fall at the Sensex scares away speculative buyers and in turn makes things a lot cheaper. Many stocks today are being offered at discounted prices compared to their earlier highs.

Many of them still continue to have growing profits and in some cases even improved fundamentals. Some of the world’s richest investors have used market corrections and pessimism to buy cheap, and create their millions and billions in the long term. 

Warren Buffet loves buying when others are pessimistic. Remember, people who create wealth do things that others don’t. When everyone panics and sells quality stocks, you can accumulate them at a lesser price. If you have a long-term perspective of at least one or two years you will create a lot of wealth.  

 So, what do you do?

Ignore those people who are busy spreading doomsday theories. Look back and you will see how the market keeps making a new high after every correction. Always keep some cash handy to make the most of these times. 

No matter what the levels of the markets, undervalued companies will always exist. In fact, a few undervalued companies I have invested in have become even cheaper now. This makes it all the more appealing for me to buy more.
So, make the most of such situations and I assure you, you will create a lot of wealth.

Why some investors quit the market

 

Imagine this: You bought some shares at Rs 280 thinking it would climb to Rs 300.
Instead it falls to Rs 210. So, you sell the shares thinking it will further fall to Rs 180. But the next day it shoots up to Rs 220.  

Now, in such a situation if you had played in ‘futures’, it would have caused enough damage to your portfolio. Futures are basically contracts, which state that you can buy (or sell) the share at a future date, at an agreed price.

Unfortunately, several retail investors have fallen into the futures trap, due to which they made huge losses so large that they end up quitting the stock market completely.

The downside of futures

I know of many small futures traders who lost a huge amount of money when the markets corrected sharply. A few of them even went bankrupt and decided to leave the markets. Had these people not traded and just invested in a few good companies they would be much richer today.  

Trading in futures has a downside to it. For example, if you have invested Rs 100 in futures, your loss would be much more than Rs 100 if the markets don’t go the way you want them to. Several retail investors play in futures simply on the basis of tips provided by their broker.   

 In the short term, stock prices tend to be very volatile and unpredictable. Several times they move in either direction without any logical explanation.  

A single announcement by the government is sufficient enough for the stock market to tumble down by 700 points. This makes trading almost suicidal.

 What drives the futures game?

One of the main factors why so many people play in futures: greed.

I agree that trading in futures is tempting. I used to trade in futures too, but stopped after making losses in 2008. I am glad I made those losses; I learnt from them. Lucky for me, they were not too huge.

The main reason I made losses: I did not spend enough time learning how futures work. I did not invest in knowledge.   

Smart advice

Experience has taught me that long-term investment is quite profitable. It may not make you rich overnight. But it also will not make you bankrupt overnight.

Don't try to make short-term gains by investing in futures. And if you want to invest in futures, do it after you have complete knowledge

It will allow you to sleep peacefully at night rather than worrying what is happening to world markets and how much more losses your futures will incur.   

Flout investment rules, at your own risk

 

Every human being has fallen down several times before learning to walk. Every rose has a thorn and every medical practitioner has to see blood. All this is part of the system and one cannot avoid them.

Similarly, inflation, taxes, government policies, geo-political situations and economic cycles affect all investments.
These risks exist in system. There is no way one can avoid them. Inflation will reduce the real rate of return from all forms of investment, may it be debt or equity or property. Similarly, taxes eat into the final returns in the hand of investor.

 In a communist economy wealth creation is difficult, irrespective of risk taking ability of an individual. Likewise, if local currency is revalued all forms of investments will get impacted. Risk that exists in system is called “SYSTEMATIC RISK.”
There is absolutely no way to avoid systematic risk. However, by adopting time averaging (popularly known as Rupee Cost Averaging or Systematic Investment Plan) one can reduce the impact of systematic risk. Investing fixed amount at fixed interval averages out impact of risk. Since more investment units will be bought at lower cost and less investment units at higher cost, over a prolonged period, averaging will start working in investors favor.  Another strategy, which is superior to time averaging, is value averaging. However due to it’s complexity it is usually not recommended.

Another category of risk is “Unsystematic Risk.” Risk which does not exist in system as a whole but which is specific to a particular asset class or particular investment product is called unsystematic risk. Other name for unsystematic risk is specific risk.
Crashing of property prices in mill area of Mumbai due to unfavorable court judgment is called unsystematic risk. Similarly, if CEO of Satyam computer resigns or put in Jail causing stock a price to tumble than it is called unsystematic risk. Another example could be of crashing of gold prices due to government control.

Diversification is best solution for controlling unsystematic risk. Diversification has different meaning to different investors. There are some who invest in six different floating rate schemes of mutual funds and feel they have diversified. Others feel that by investing in different stocks they have diversified e.g. their portfolio will consists of HLL Ltd., Marico Industries Ltd., Gillette India Ltd and P&G Ltd. A closer look will tell you that all are FMCG stocks. Yet, there are few who diversify through different investment vehicles e.g. They would have mutual fund schemes which invest in equity, ULIP which invest in equity and would also have rendered services of portfolio manager for their equities.

Diversification means investing in asset classes, which has negative correlation. In nonprofessional’s language, it means that when performance of one asset class goes up, other asset class falls down. This will ensure that overall portfolio returns remain stable. If the explanation has to be further diluted, it would state that do not place all your eggs in one basket. By diversifying the portfolio, unsystematic risk is significantly reduced.

There can never ever be risk free return. Risk free return does not exist. In fact, return is solely a factor of risk. However, proper understanding of risk will assist in generating higher returns with same amount of risk

The balancing act part I: Risk vs. Return

As an investor your objective is simple – 'Maximize return and minimize risk'. The first part of the equation, the return, is relatively easy to understand. It is objective in nature, in as much as, when you undertake an investment, you have a fairly good idea as to what the return is going to be. It is quantifiable and it is a number.

However, what about risk? How do you quantify it? How do you minimize it? How do you achieve the fine balance required between risk and return to optimize your investment consistent with your goals?  

Systematic Risk

 Systematic Risk, as the name suggests is the risk inherent in the economic system. Macro factors such as domestic as well as international policies, employment rate, the rate and momentum of inflation and general level of consumer confidence etc. are what constitute systematic risk. Generally, investors cannot hedge or diversify against this risk as it affects all kinds of asset classes and affects the entire economy as such.

Unsystematic Risk 

This is the risk inherent in a particular asset class. The best way to combat this risk is by diversification. However, one must remember that the diversification must be in the class of asset and not the asset itself. An example of the above is evenly distributing your portfolio in bank deposits, Reserve Bank of India (RBI) bonds, real estate and equities. That way if a certain unsystematic risk affects let's say the real estate market (say the prices crashes), then the presence of other classes of assets in your portfolio saves you from a total washout. However, note that diversifying within the same asset class (buying different equity shares) is not strictly combating unsystematic risk. Understanding Unsystematic Risk 

Interest Rate Risk 

Interest rates in the economy may fluctuate due to several factors such as a change in the RBI's monetary policy, Cash Reserve Ratio (CRR) requirements, forex reserves, the level of the fiscal deficit and the consequent inflation outlook etc. Extraneous factors such as energy price fluctuations, commodity demand and supply and even capital flows may result in rates fluctuating.

Then there are the event-based factors that affect interest rates. For example, the 11/9 episode in the United States of America and 13/12 in India. If there is a war, interest rates will rise. However, typically such events are temporary in nature and in fact a good fund manager can actually take advantage of them.

To illustrate how fluctuations in interest rates affect the returns, let us take the example of mutual funds (MFs). Adjusting the portfolio to the market rate of returns is called 'marking to market'.

We assume that the current Net Asset Value (NAV) of the MF is Rs. 10 and its corpus is Rs. 1000 crores. This means that if the fund sells all the assets of the scheme and distributes the money on equitable basis to all the unit holders, they will receive Rs. 10 per unit. Now suppose, the interest rate falls from 10% to 9%. Immediately, thereafter you wish to invest Rs. 1 lakh in the scheme. Realize that the entire corpus of the fund stands invested at an average return of 10%. If the fund sells the units to you at it's current NAV of Rs. 10, you will be allotted 10,000 units. This will benefit you immensely. You will be a partner in sharing the benefit of the higher returns of 10%, though the fund will be forced to invest your Rs. 1 lakh at the lower rate of 9%.

This is injustice to the existing investors. Therefore, something has got to be done to protect their interest. Here comes the 'mark to market' concept. The fund raises its NAV to Rs. 11.11. You will be allotted only 9,000 units and not 10,000. The returns on 9,000 units at 10% would be identical with the returns on 10,000 units at 9%. In other words, the NAV rises when the interest falls

Credit Risk

This is the risk of default. What if the company whose fixed deposit you invested in goes bankrupt? There have already been several such cases. Deposits with plantation companies and time-share resorts are more cases in point. True, you have legal remedy...but everyone knows how much time our courts take. 

The only factor, which dilutes this risk somewhat, is the credit rating. Fixed income earning instruments get rated for varying degrees of safety. Investing in a highly rated instrument is safe but not sufficient. Firstly, the instrument may be down graded; you have to be on the lookout for the same. Then there have been cases where the issuer has got rated by different agencies but chooses to indicate only the higher ones.

Well, age-old statistical tools like standard deviation and regression help us do precisely that. Next time we shall touch Interest rate risk discussed earlier is always prevalent. However, it comes into play only when a transaction is undertaken during the tenancy of the fixed income instrument. Ergo, it follows that if the investment is held till maturity, there would be no interest rate risk. Investments such as Public Provident Fund (PPF), Relief Bonds etc. are normally held till maturity. These are examples where both the risks inherent in debt instruments are at a bare minimum. 

When the stock market crashes

First, cut out all the noise and clutter around you and get back to basics. This is because 90 per cent of the people around you are as clueless as you are. So, when you let the facts speak for themselves, you have a better chance of eliminating ambiguities. Let's find out what these are.   

Fact 1: The equity market is NOT a lottery ticket. Every share has a fundamental value and is based on the company’s performance

Fact 2: It is possible for share prices to be widely different from their intrinsic value

Fact 3: In the long run, share prices always move towards their true value depending on the profitability and growth potential of the company.

Fact 4: Irrespective of whether the United States goes into recession or the sub-prime problem generates more losses, India’s economic growth rate will still be comparatively high.

 Fact 5: Unless we have some serious calamity, a political crisis or poor monetary or fiscal policy, we may continue to see over 7 to 7.5 per cent growth rates over the next 5 to10 years.

Fact 6: If the economy continues to grow at such a healthy rate, it has to reflect in the corporate performance as well. This will lead to appreciation of the share price sooner or later.

Keeping these facts in mind, the long-term outlook for India still remains quite positive.

Quick lessons!

1. Do not panic.
2. If you have invested in good companies stick to these choices.
3. It's a good time to invest in the market.
4. Be patient and disciplined. You will be rewarded