These New Year2011 resolutions will help you avoid past mistakes and enable you to make disciplined stock choices
Risk can never be avoided; it can only be reduced or contained.
CALL it the magic of New Year. There is something in the air that gives you the confidence to set things in order. And the mood is no different among investors. There is a desire to avoid the mistakes made in the past to ensure better growth in the future.
Avoid The EFGH Factor:
We have learned alphabets in the school. But it's time we revisit a few of them. Investors should keep the EFGH factor in mind when they invest in equity markets.
In EFGH, E stands for excess of 'Emotions', F for 'Fear', 'G' for 'Greed' and 'H' stands for 'Hoping Against Hope'.
Since these four factors have the potential to ruin the prospects of any equity investor, you should always try to keep them under control. They have the power to take control of an investor's rational faculties by making him run after impossible goals that can cost him dear.
As the wise men in the market say, an equity investor should learn how to become fearful when others are greedy and greedy when others are frightened. Well said, because the best of the opportunities are available in the equity market when fear runs amok on Dalal Street. It's the time when one can shop at bargain prices.
This doesn't mean that one shouldn't be optimistic. This is just to caution against being incorrigibly optimistic — hoping against hope that things will turn around the way you want them to b e. This is painfully true when one buys the wrong stock or a stock which costs more than its fundamentals can justify. In such cases, small investors generally enter into the last leg of the upward trend due to their greed. But as the stock starts falling below its purchase price, investors get stuck and keep waiting to exit at the purchase price. Their hope of exiting at 'the purchase price' is a classic case of hoping against hope as in most cases such overvalued stocks drop to very low levels. The investor then remains saddled with such junk for a long time. And, even if he manages to exit at the purchase price, the time that has elapsed between the buy and sell ensures he loses in terms of 'time value'.
Be Objective:
You will gain most by being objective. You have to be objective when it comes to valuation of a business. There is a tendency to value one's own belongings at a price more than the fair price. An investor tends to think the shares that he owns are better placed to move up than the shares he does not own. Experts in behavioural finance call it the 'endowment effect'. It makes sense for investors to listen to the arguments against their investment decisions. There are instances where investors get into the 'denial mode'. In dynamic markets, the business conditions may not remain favourable always. This is especially true for cyclical stocks. Changes in regulatory frameworks also impact business prospects. In such cases, getting into the denial mode can be fatal. A case in point is the telecom sector. Till 2007, telecom was one of the biggest wealth creators for investors. But many could not accept the possibility that the earnings may see a downward trend due to increased competition in each circle. Those who could not accept the changed matrix of telecom, could not capture their gains at the top.
Do Due Diligence:
Investors should start their new year by looking at their existing portfolios through the 'due diligence' lenses. Due diligence helps investors identify fundamentally sound companies and avoid stocks with no fundamentals. Small investors should avoid the temptation of buying operator-driven stocks, as one may get caught at higher levels. Do your homework well and then commit your hard-earned money. Try to gather information about the company from independent and authentic sources of information such as the stock exchange and industry forums. It makes sense to have critical opinions about the business at hand to form the right opinion about it. At times when there are scams mushrooming up, leading to stock price crashes overnight, it is imperative that you partner with the right stocks. Though it is a tedious process, it is better to inculcate the habit of doing the home work on your own.
Stay Independent:
It is a sought-after trait in the equity markets. Successful investing in most cases is not a group activity but the outcome of an individual's brain that can think independently. Subscribing to consensus is the common tendency most investors exhibit. This deprives them of many opportunities. Take the simple example of the exuberance of early January 2008. The market was quoting at the highest valuations (Nifty P/E was at 28) after the magical bull run that started in 2003 and the fundamentals were lagging by a wide margin. But that did not prevent most of the small investors from investing fresh money in the market, forget taking money home by selling out their equity holding. No wonder then that many such naïve investors came crashing down from those unrealistically higher levels. And then as most investors subscribed to the 'consensus' estimates of a doomsday, few could think independently. The obvious outcome was that most could not buy into equities near the bottom in October 2008 when the Nifty was quoting around 10 times its trailing 12 months' earnings. The fear in the air immobilised investors, making them incapable of using their common sense since most could not think independently.
Investors should develop the habit of thinking independently to earn alpha returns in excess of market returns. At a time when global investors have recognised the India growth story, the opportunities will come only from independent thinking. Those seeking social approval generally end up with mediocre investment opportunities that offer market returns or less than that.
Just Be Yourself:
Understand your abilities and your weaknesses as an investor. If you don't have time on hand or lack the necessary skills to analyse individual stocks, it's best to no gamble in the market. It makes little sense to envy your neighbour who is making some quick money in the markets. It pays to invest for the long-term after doing some homework.
As the complexity of the equity market increases, most individual investors find it difficult to invest in equities on their own, which makes a strong case for mutual fund systematic investment plan that offers expert handholding in equity investing at least cost," says Sadanand Shetty, vice-president and senior fund manager, Taurus Mutual Fund. Stay with diversified equity funds with a good track record.
It is time to stick with good long-term solutions than to keep jumping from one fund to another looking at short-term performances. Then there are instances where the distributors may push the wrong product in the 'tax saving mania' scheduled to be unleashed from January to March, 2011. Better ask questions till you get the complete picture with the underlying risk-reward proposition. This will help you understand the products on offer and avoid those that you do not need. The New Year will reward you if and only if you resort to a more disciplined investment approach.
PROMISES TO KEEP
For direct equity investors: I shall…
Ø Keep my returns' expectations at realistic levels
Ø Do my homework before investing in equities
Ø Not invest in any stock on tips
Ø Invest for long-term in fundamentally sound companies
Ø Try to balance my emotions in all market scenarios
Ø Remain open to views that contradict my views
Ø Keep my actions based on reasoning than anything else
For indirect equity investors: I will
Ø Understand my needs before I look at the investment options
Ø Not buy anything that does not address my requirements
Ø Gather information about the product on offer
Ø Not invest in a scheme looking at short-term performance
Ø Invest in schemes with long-term track record across market cycles
Ø Stick to long-term solutions and invest in diversified funds
