Once again, investors are in a manic-depressive mood. They undergo bouts of wild joy when they see where the markets are heading and how the value of their investments has increased. At the same time, they are sick with worry about whether they should stay invested and whether they should invest more.
The stock markets have reached higher than they have ever done before. This is a good thing for investors but is also a dangerous one. Remember, more bad investment decisions are made when the markets are at a high than at any other time. All-time highs may be exciting, but all savvy investors know that at times like these one’s thoughts should be on what not to do rather than on what to do.
We know it’s difficult to control one’s excitement, but this is the right time to get back to basics and reaffirm one’s knowledge and faith in the basics of investing. Here are some simple rules and principles that will ensure that you can prevent yourself from making the worse mistakes that the stratospheric heights of the stock markets can induce.
1. It isn’t different this time, not really:
Every bull run brings out the chronic optimist in investors. This time, we feel, things have changed fundamentally and the markets will go on rising up for a long time. Sure, we feel, they may pause a bit, but surely they won’t fall ever again. Every great bull run that the Indian markets have seen in living memory has come complete with a set of reasons ‘proving’ why it was different this time.
2. Bulls are no substitute for knowledge and understanding:
As the stock markets rise, most people appear to need fewer and fewer justifications for investing. A couple of years ago, when the markets were down in the dumps, hardly anyone would make an investment without putting it under a magnifying glass.
When the markets started rising, the focus seems to have shifted to what one may call faith-based investing. Investors have faith in the general talk of how the markets will keep on rising and therefore find almost any investment worth making, regardless of how little they know about it. The feeling is that the markets will go on rising and therefore all stocks are worth investing in.
My advise is simple–do not invest in stocks, sectors and funds that you do not understand. And if you do not have the time or the inclination to understand anything specific, stick to a handful of mainstream diversified and balanced funds.
3. You can’t have it all:
‘Buy low, sell high’, goes the oldest mantra of the markets. Yet investors do their returns much damage by trying to ‘Buy lowest, sell highest’. No matter how much you try, it isn’t possible to time the markets with a reasonable degree of accuracy. If you insist on waiting to realise all possible gains by selling at the very highest point, you are likely to miss it altogether.
If you want to make money with a reasonable certainty, don’t mind leaving some of it at the top of a price peak. If you’ve made reasonable gains, get out without agonising over unmade gains–you won’t lose anything.
4. It doesn’t matter whether the Dow Jones makes sense:
One question that most financial media is obsessing over is whether fundamentals justify the levels to which the markets have risen? Clearly, the answer to a question like this is expected to have a certain predictive value. Implicit in the very act of asking such a question is the idea that if the markets’ level is justifiable, then it will be sustainable and if it is not justifiable, then this level will not be sustainable. This is something that we do not believe in.
It goes without saying that there are many clouds on the horizon. Oil prices, the slow-motion collapse of the US Dollar, rising inflation and interest rates could all dampen things. Of course, ‘the fundamentals of the market’ are a bit of a red herring. As every investor (and even some day traders) know, there is no such thing as the fundamentals of the market.. To real investors, even the index is of only marginal interest and what matters are only the numbers behind the stocks they are holding. The worst danger of high stock prices is not in the prices themselves but in the irrational optimism that they start engendering after a point. Just about any market level is fine as long as investors keep a cool head and don’t think of investing only when the market is rising.
5. Beware of the hype machine:
All financial media: the pink newspapers, the business channels on TV and the business magazines see their business improve when the markets go up. The media does all this because its good business but it does create an atmosphere of frenzy that drives people to invest NOW! The feeling that if one will miss a lifetime’s opportunity by not investing immediately takes over and that leads to bad investing decisions. Investors need to guard against getting too involved by the media hype.
6. Value matters:
When the markets are rising, its easy to forget about whether the stocks you are getting into are good value at the price you are paying. There are plenty of good stocks that are just too overpriced at a point like this.
It doesn’t sound likely that the number of worthwhile investments would actually rise when the markets rise, yet if one is to look at the ‘research’ that is being churned out, there are more ‘buys’ now than earlier. Clearly, researchers and investors have stopped looking at whether some investments are justifiable at current prices.
7. Did you do it, or did the market?:
One of the strangest things that happen in a broad rally is how every investor gets convinced that it is his genius that is delivering gains and not the market. We have a situation where almost every stock and fund is rising sharply. Over the last couple of years, practically all that has been necessary to get good returns is to just invest.
In this situation, there is a temptation for investors to look at their portfolio, see how everything is gaining and convince themselves of their own investing genius. In a strong bull-run, investors must keep both feet on the ground by continuously comparing the investing performance of their entire portfolio (and not just one or two stocks) with some external benchmark. This will keep things in perspective.