Behavioural traits of a successful investor

To be a successful investor in the stock market, one needs to develop several skills:

• Learn how the stock market functions – the roles played by short-term traders, long-term investors, operators, company promoters, brokers, FIIs, DIIs, NSDL/CSDL, stock exchanges, SEBI
• Know about the various types of securities that are traded – stocks, convertible and non-convertible debentures/bonds, warrants, ETFs, mutual funds, bonus/rights shares, bonus/rights debentures
• Be aware of related information – dividends, interest on debentures/bonds, tax implications of buying and selling of various securities
• Have working knowledge of economic concepts – supply and demand, money supply, inflation/deflation/stagflation/recession, surplus/deficit, interest rates, impact of global economies on domestic economy, effect of economic changes on different business sectors
• Reasonable proficiency in accounting concepts – debit/credit, assets/liabilities, capital/reserves, equity/preference shares, payables/receivables, raw materials/inventory, profit/loss, cash flows, and ability to calculate and compare EPS, P/E, P/BV, RoNW, RoCE, Debt-Equity ratio, etc.

But the most important skill of all is to learn about oneself – the behavioural traits that determine who will be a successful investor and who will be an ‘also ran’.

In a recent article posted at investopedia.com, the following behavioural model developed by Bailard, Biehl and Kaiser was presented:

Investors are classified according to their decisions and actions (‘impetuous’ at one end and ‘careful’ at the opposite end) as well as their levels of confidence (‘confident’ at one end and ‘anxious’ at the other end). Based on these behavioural traits, investors are divided into five groups:

• Celebrity – anxious and impetuous, a follower of the latest investment trends
• Adventurer – confident and impetuous, a strong-willed risk taker
• Individualist – confident and careful, with an analytical and self-reliant approach
• Guardian – anxious and careful, willing to sacrifice riskier growth for more stable returns
• Straight Arrow – equally shares the above four behavioural traits

Apparently, greatest investment success is achieved by those with the ‘Individualist’ behavioural trait. What if one has one of the four other behavioural traits? Should they exit from the stock market?

With discipline and perseverance, behavioural patterns can be changed – provided one is aware which behavioural category one belongs to.

Moral of the story? To be a successful investor – know thyself.

Related Posts

Become a successful investor by avoiding 'herd mentality'

Are you an irrational investor?

Some practical examples of Behavioural Finance

A strategy to beat that ‘missed out’ feeling

A sudden gush of FII money has propelled the Nifty to a 1000 points gain from its Dec ‘11 low, and caught experts and small investors unawares. What had looked like a typical bear market rally is beginning to look more like the first stage of the next bull market.

Many who failed to buy at the low prices of 2011, and those who booked profits and moved to cash in the hope of buying at much lower prices, are feeling that they ‘missed out’ on the rally. How do investors ensure that they don’t miss out on opportunities to buy (or sell)?

In this month’s guest post, Nishit discusses the FoC (Free of Cost) strategy to beat that ‘missed out’ feeling.

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The stock market has rallied more than 20% from the Dec ’11 bottom. Many of us are feeling left out from this rally. What must one do to avoid such a situation? The stock market is one place where one can create a lot of wealth over the long-term. So, how does one go about doing this?

Step 1: Identify about 10 businesses which you feel will do well over the long term (as in next 5-10 years). Remember you are investing in businesses - not only stock prices.

Step 2: Once these businesses are identified, keep a watch on their stock prices. The strategy one will adopt is to keep investing into these stocks at regular intervals.

Step 3: With knowledge about the stock market and Nifty, buy these stocks at attractive valuations. There are 3 things which can happen to the stock prices. They can go up, go down or remain flat.

1. If the prices go down, be ready to average the stocks and buy them at a cheaper rate. For doing this, awareness of the broader trend of the market helps a lot.
2. If prices go up, be ready to book profits. One very effective way of doing this is by making the shares ‘Free of Cost’. Let me give you the example of SAIL. Say 100 shares were bought at Rs 90. Now the price has rallied to Rs 110. I feel I had enough of the ride and expect a correction in the markets. I book out 84 shares and remove my cost price. Now, the remaining 16 shares are free for me (i.e. my holding cost becomes zero). I know that SAIL will continue making steel for the next 10 years (and may be much longer than that). These 16 shares I will not touch unless there is a blow out rally where the Nifty trades in 22 + P/E which would be around 6300+.
3. If prices remain flat, I just wait and watch.

With this strategy, I will not be sad if prices go up and I have not bought anything fresh. If prices go down, I will be having cash to add to my holdings.

The risks to this strategy are the identification of the companies. If one goes for fly-by-night operators and the company goes bust, then one is in trouble. The ‘Free of Cost’ shares become worthless. Hence one has to keep a watch on the fundamentals of the companies and take a call to move on to other stocks.

This approach combines both fundamental and technical aspects. In the last year itself there were 4 bear market rallies. Even if one had booked with about 15-20 % profits one would have had a sizeable quantity of ‘Free of Cost’ shares right now.

This is one way to create long term wealth in the stock market.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

A common investing mistake - and its remedy

A common investing mistake made by many small investors is to wait far too long, and let buying or selling opportunities slip away. When the stock market is rising, and portfolio values go up in leaps and bounds, the tendency is to hang on to the stocks or funds in the portfolio to try and squeeze out the maximum amount of profit. The wait to sell keeps getting longer and longer and one fine day, the market cracks for no apparent reason. The investor rues the fact that a selling opportunity near the top was missed.

When the stock market is falling, the same psychology plays out in reverse. Investors try to buy a selected stock or fund at the lowest possible price, and keep waiting and waiting to buy at even lower prices. Out of the blue, the market turns and starts to rise - as if throwing caution and common sense to the winds. A buying opportunity near the bottom is missed.

Seasoned professional investors find it tough to correctly time stock market tops and bottoms. Imagine how much more difficult it is for amateur investors to catch market tops and bottoms. It is not worth trying unless one has become adept at identifying technical signals - and that takes years of practice.

There is a simple way to remedy the mistake of waiting too long and losing opportunities. Inculcate the habit of being fully invested. Regardless of whether the stock market is moving up or down. But it requires a bit of planning and a large dose of discipline. First of all, investors require a financial plan based on their income, savings and existing and future financial commitments. Help can be sought from a professional financial planner (for a fee) or a CA friend (for free). But it isn't rocket science. Knowledge of Class 5 arithmetic is good enough to do it yourself.

Then one needs an asset allocation plan, based on risk tolerance. This post explains the concept of an asset allocation plan. Once the plan is in place, investors should have the discipline to stick to the plan at least for two or three years. Change the plan only if things don't work out. Investing without a plan is like travelling without a destination.

If the asset allocation plan indicates it is a good time to buy (because the equity portion of the allocation has fallen below a pre-set threshold level), start buying systematically. By using cost averaging or value averaging concepts. Read about these concepts in this post. Identify a couple of good stocks or funds. Then decide how much of each you want to buy value-wise. Spread out the buying over a few months, till your asset allocation plan is rebalanced.

If the asset allocation plan indicates it is time to sell (because the equity portion of the allocation has exceeded a threshold level), don't wait any longer. Start booking profits partially. To find out more about partial profit booking, read this post. Remember to keep the flowers and cut the weeds in the portfolio first.

10 Reasons why small investors should love a bear market

Most small investors detest a bear market. The helpless feeling of watching stocks bought with hard-earned money falling into oblivion can be quite traumatic, and cause sleepless nights.

In a desperate and misguided effort to salvage a losing position, investors start ‘averaging’ – buying more shares at progressively lower prices. The stock doesn’t know that some one is ‘averaging’ it – and keeps going down further! The ‘average’ price of the stock decreases, but the losses increase.

Is there any remedy for this fairly common ailment? Turn a disastrous situation into a learning experience. Find out the reasons why small investors should love a bear market. Here are 10 of them.

1. Every one loves bargains. The best bargains in stocks are found during a bear market. Good stocks are available at 40%-50%-60% discounts to their recent peak values.

2. Experts and analysts appearing on TV or writing in business papers stop recommending third rate stocks. They may actually discuss about some decent companies. No longer will you hear that Suzlon is a great buy or Bartronics is the next Infosys.

3. Email or cell phone inboxes will not get overloaded with SMS stock tips about unknown companies from unknown brokerage houses. Most of those brokerages go belly-up during a bear market.

4. No one wants to discuss about stocks at weddings or college reunions. One can actually have intellectually stimulating conversations with relatives and friends – instead of saying “I’ve bought this” or asking “Why did you sell that?”

5. Working hours will not be wasted by staring at stock tickers scrolling on computer terminals. Up to the minute stock updates on cell phones will get disabled. Productivity at work places will improve.

6. One can get a haircut or a shoeshine in peace without getting stock tips from the barber or the shoeshine boy.

7. A bear market separates the short-term, one-hit rock-star companies from the true long-term wealth creating companies. The stocks that don’t fall much in a bear market are the ones that provide dividend income and stability to your portfolio.

8. If one is unfortunate enough to come face to face with a bear in a forest, the best thing to do is not to run or try to fight but to play dead. In the stock market, one can play dead by investing in fixed income avenues. Interest rates are usually higher at such times.

9. The importance of proper asset allocation becomes clear. Spreading investments among equity, fixed income, gold and cash not only saves a portfolio from annihilation but the asset allocation gives clear signals about when to buy and when to sell.

10. A bear market tests an investor’s mettle. Those who turn tail and run are just not meant to be successful investors. Those who can stick it out and learn from their mistakes are the ones who may be able to build wealth over the long term. 

Are you ready to splurge at the discount sale in the stock market?

Discount sales in retail stores happen several times during the year. They advertise ‘buy-one-get-one–free’ sales and ‘upto 50% discount sales’ that bring in buyers by the hordes. If you have ever visited a retail store on the last day of such a sale, you will find a scene of utter devastation – stuff strewn all over the place and buyers practically yanking things off other buyers in a last desperate bid to find a bargain buy.

What is interesting is that the same buyers (or their friends or cousins) become completely reticent when a discount sale is going on in the stock market – keeping their wallets glued to their pockets. No one rings a bell or takes out full-page advertisements in newspapers to announce a sale in the stock market. One fine day, when everything seemed to be full of sunshine and happiness, people realise their stock or mutual fund portfolio is decreasing in value. Stocks and funds that were flying into orbit suddenly start to nose-dive.

The initial reaction is usually denial. This must be a temporary phase. The correction will soon be over. Experts suggest: “Buy the dip”. Those who entered a bull market late (they are mostly new investors attracted like flies to a pot of honey) start ‘averaging’. When the stock market continues to fall, denial is replaced by shock. All the ‘averaging’ does not prevent a stock’s price from crashing. In sheer panic, investors sell off their holdings to recover whatever little they can.

That is when the real sale starts in the stock market. Experts opine that the index can’t fall any more; 4700 or 15700 or some such number should be the bottom; this is a good time to buy into blue chips. And then the stock market decides to offer even better discounts! But where are the buyers? Why aren’t they falling over each other in trying to lock-in the best bargains?

Many years ago, in a training class on the art of selling, I learned two important lessons. The first lesson: When some one leaves you a message stating that the ‘matter is very urgent’, the urgency is the person’s who left the message. He has probably not yet met his quarterly or yearly sales target – which means no bonus payment and may be even a ‘pink slip’. Don’t call the person back. Let him call again.

The second lesson: When some one offers you a very good deal – so good that you are tempted to whip out your cheque book – smile politely and refuse. The deal will usually get even better! Those who have negotiated a car purchase – particularly a second hand one – will know what is being discussed.

The same goes for Mr Market. He announces discount sales only once in two or three years – not several times a year like retail stores. But if you have the patience and skill to ‘negotiate’, keep smiling and refusing to accept his offers. Even if strong performers are trading at 52 week lows. You will find that his offers get even more mouth watering.

At some stage, Mr Market will get fed up with you (and others like you) and start increasing prices – not in one shot, but gradually. Much like the way he kept offering better discounts with each passing week. That is the best time to start buying. You may not get the absolute lowest bargain price. But you can sleep peacefully at night knowing that henceforth, prices will start rising. 

Why do small investors get ‘cheated’?

The cynical answer to the question is: Because they deserve it. The cynicism can be explained by a recent incident during my last visit to the local market.

I was buying half a kilo of Kashmiri apples – the small, roundish kind with alternate patches of bright red and light green colours. They have a crisp, lightly sweet and fresh taste that takes me back on waves of nostalgia to my only trip to Kashmir more than 50 years ago. A place of such pristine and gorgeous beauty I have rarely ever seen again. But I digress.

As is my habit, I asked the rate per kilo, and was told by the young fruit vendor that it was Rs 80. As the young fellow was weighing the fruits, a middle-aged gentleman came by. He wanted to buy half a kilo of the Kashmiri apples as well, and proffered a Rs 50 note with this comment: “It is Rs 100 a kilo, isn’t it?”

The fruit seller glanced at me quickly, and observing my blank expression, simply nodded his head and promptly took the Rs 50 note. Now, being overcharged Rs 10 for half a kilo of apples may not seem like a big deal. The point is, the buyer unnecessarily tried to show-off that he was a knowledgeable buyer, and allowed himself to be ‘cheated’.

Should I have pointed out the correct price to the buyer and saved him Rs 10? That would have broken the mutual trust that has developed between the young fruit vendor and me over the past several years. I pay him whatever rate he asks, and he always gives me the best fruits from his pile.

What does all this have to do with investments? Change the ‘half a kilo’ to ‘500 shares’; ‘Kashmiri apples’ to ‘Dabur India’ (say); and ‘young fruit vendor’ to ‘Rakesh Jhunjhunwala’ (or, Ramesh Damani). A small investor could have bought Dabur shares for Rs 80 a few months back, but may choose to buy them at Rs 100 now. Due to the bear phase, the stock goes nowhere. After a couple of months, the stock’s price may drop to Rs 90, and the investor will probably exit in a hurry with a Rs 10 loss. Except that the loss is not Rs 10, but Rs 5000 – since the original quantity bought was 500 shares.

The investor feels ‘cheated’ because he bought a well-known FMCG stock, and still lost a decent amount of money. The fact that he made a couple of serious mistakes - buying at a higher price, and then selling at a loss because of a short-term mentality – may not dawn on him. A few more similar experiences may keep the investor permanently away from the stock market – with the feeling that the market is ‘manipulated by operators’ to ‘cheat’ innocent investors.

The moral of the story? Don’t allow yourself to be cheated. Do some prior preparation and planning. Talk to veterans of the market. Read a few books. Understand how the game is played. Opening a demat account and a trading account is a necessary formality but not adequate preparation for buying stocks.

Why long-term investors should look at the big picture

With the Sensex and Nifty indices stuck within trading ranges for more than a month, small investors are in a quandary. What to do next? Two days of sharp bounce from a bottom, and the urge to jump in and buy is almost uncontrollable. Three days of correction from a resistance level, and every one is worried about a 2008-like crash.

Getting worried and disturbed about short-term index gyrations only increases your blood pressure and clouds your decision making. Times like these are true tests of your investment mettle. In life, unplanned action is some times better than planned inaction. But, for building wealth through successful investing in the stock market, you should practice the discipline of planned inaction.

The inaction refers only to buying and selling of stocks. Reading annual reports, books and preparing buy/sell lists are part of the daily ritual of  long-term investors. What then is the big picture referred to in the headline? I’m not an economist, but here is my take on what is happening around us.

Thanks to the Internet and FIIs, our stock market is fully integrated with global markets. All the nonsense about decoupling because of our strong domestic market is just that – nonsense. So, keep an eye on what is happening in global markets. To keep readers updated, I regularly post about stock indices in the US, Europe and Asia. If you are not reading those posts, ask yourself: Why not?

Europe is in quite a mess due to a unified currency that is not helping profligate nations - like Greece, Italy, Spain, Portugal - that are deep in debt and have very little capabilities (or even intentions) of repaying that debt. They neither can print their own currencies, nor can they devalue their currencies. The only options are that a financially stronger economy like Germany, and perhaps the IMF, will bail them out to stop them from defaulting. But that is postponing the problem – not solving it.

Many Indian companies – particularly IT services companies – switched their export focus from the USA to Europe post the dot.com crash in 2001. Some have built up significant businesses in Europe, including acquisition of European companies. The economic mess in the Eurozone is going to affect their bottom lines for the next few years.

China is a wild card. For years, they have been far ahead of India in building world-class infrastructure and an export-led high-growth economy. But with global economies slowing down, China is desperately trying to re-focus on their domestic market. There is strong suspicion about their reported growth figures, and that is reflected in their sliding stock market. If they start cutting back on their commodity purchases, which has been sustaining the global commodities market and shipping businesses, a big crash in global stock markets may follow.

The USA is not on the verge of collapse – like they were three years back. The situation is grim, but not hopeless. There will be a lot of pain before their economy eventually turns around. But thanks to two rounds of quantitative easing, and significant belt-tightening, US corporations are sitting on a lot of cash. They haven’t curtailed spending on existing IT services, and there are signs that they may be spending more on new services. The strengthening dollar will add to the bottom lines of IT services and export companies.

Our over-dependence on oil imports will further add to our balance of payments problem. The government had introduced several populist measures to help the rural poor. Subsidies on diesel, kerosene, fertilisers have added to the fiscal deficit. Rampant corruption and scams, as well as high inflation are keeping FIIs away. Their inflows partly help in reducing the deficit.

However, our GDP continues to grow. Not at 8-9% but more like 6-7%, which is much better than almost every one else except China. That pretty much rules out a 2008-like crash in the Indian stock market. But it could take a while before we see new highs on the Sensex and Nifty.

The sensible approach will be to cut out the daily noise emanating from the business TV channels, and concentrate on companies that have capable and trustworthy managements, and have records of several years of good performances through bull and bear cycles. If they produce goods or services that find buyers regardless of the state of the economy, so much the better. Companies that sell toothpaste, cigarettes, soaps and detergents, biscuits, life-saving drugs, drugs for chronic diseases, tractors, power tillers, tea and coffee will continue to do well.

Just remember that the stocks that don’t fall much during a down trend, don’t rise much during the subsequent up trend. The ones that fall more, tend to rise more. Of course, this ‘rule’ works only for well-managed companies.

Why small investors should emulate a convicted murderer in Texas

The Texas Department of Criminal Justice executes more condemned men than any other state in the USA. Traditionally, condemned men were granted a last request. Most death-row inmates chose to have an elaborate last meal before going to the ‘gallows’.

This practice has recently been stopped, thanks to convicted murderer Lawrence Russell Brewer – a member of a white supremacist gang who brutally murdered a black man by dragging him behind his truck for several kilometres before dumping his decapitated body near a cemetery.

Brewer ordered the following last meal before his execution:-

• Two fried chicken steaks with gravy and sliced onions
• A triple-patty bacon cheeseburger
• A cheese omelette with ground beef, tomatoes, onions, bell peppers and jalapeno peppers
• A bowl of fried okra with ketchup
• One pound of barbecued meat, accompanied by half a loaf of white bread
• Three fajitas
• A meat lover’s pizza
• A pint of Blue Bell ice cream
• A slab of peanut butter fudge with crushed peanuts
• Three root beers

No human being can possibly consume all that food in one sitting. In fact, when the meal arrived, Brewer refused to eat by saying he wasn’t hungry. He was deliberately manipulating the system. He ordered whatever he felt like, because he could – and then declined to eat it.

What does this bizarre tale have to do with small investors? The stock market displays a smorgasboard of alluring stocks from junk companies with questionable promoters that trap unwary small investors. After losing their shirts, small investors complain about ‘operators’ manipulating the system to deprive them of their savings.

Be a smart investor instead. Substitute each of the junk food items in Brewer’s last meal with companies like Cranes Software, Karuturi Global, Bartronics, Punj Lloyd, Suzlon, IVRCL, Delta Magnets, Reliance Communications, Kingfisher Airlines, Temptation Foods (!). Then ‘manipulate’ the system in your favour by refusing to buy any of their stocks. Only buy stocks of well-respected companies with proven managements at reasonable valuations, and you will never go wrong.

To make money in the stock market, avoid these three buying mistakes

Stock markets have trading days or holidays. Using stock market jargon, trading days can be either ‘bullish’ or ‘bearish’. But if you follow the so-called experts on business channels or the pink papers, stock markets have ‘good’ days or ‘bad’ days. On ‘good’ days, the Sensex gains. On ‘bad’ days, the Nifty falls.

What happens when both the Nifty and the Sensex drop by 4% – like they did today? It is a ‘terrible’ day! For whom? Obviously for the brokers and the business channels, because their business thrives on ‘good’ days. When the market moves up, more viewers tune in, and more investors place ‘buy’ orders. For investors, who were lucky or prudent to sell at higher levels, ‘panic’ days offer a great opportunity to cover back the stocks sold earlier.

So, are ‘panic’ days great opportunities to buy? The short answer is: No. In an earlier post, ‘How to tackle a ‘panic bottom’, I had explained that panic bottoms seldom hold. Technically, today’s heavy FII selling didn’t create a bottom in the Sensex or the Nifty. But it is a sign that the lower level of the last six weeks’ trading range may get tested, and possibly broken.

If you ever watch a tennis match between a top 10 player and a player ranked much lower, you will notice that there may not be much difference in their respective skill levels. The big difference lies in their ‘unforced errors’ stats. The better player makes fewer ‘unforced errors’.

In stock market investments, there are three such ‘unforced errors’ that you must learn to eliminate to enjoy greater success. These are common buying mistakes that many investors make:-

1. Buying near a top
2. Buying during a down trend
3. Buying before a bottom is formed

The buying mistakes in 1 and 3 are caused mainly due to inexperience with technical analysis. In the majority of bull and bear markets, a top or a bottom just do not happen out of the blue. There is a process, usually accompanied by a clearly identifiable reversal pattern, through which a top or a bottom gets formed. Such reversal patterns may take a few weeks, or a few months to form.

In both the Sensex and the Nifty, the Nov ‘10 peaks were part of ‘diamond’ reversal patterns, which transformed into large ‘descending triangle’ reversal patterns. So, we actually had two reversal patterns to indicate a change of trend from bull to bear.

The 2008 bear market ended with a 5 months long rectangular reversal pattern. It is expected that the current bear market will also form an identifiable pattern before the next bull phase can start. No such pattern is visible yet.

It is easier to identify reversal patterns after the pattern is fully formed. But there are prior signals given by various technical indicators that help to ascertain whether a reversal pattern is in progress. It is better to err on the side of caution when stock markets are rising or falling fast.

Buying during a down trend is acceptable only if you are covering up an earlier sale at a higher price. Not otherwise. Unlike tops and bottoms, which are tougher to identify, a simple trend line or the 200 day EMA can show whether a stock or an index is in a down trend. The biggest mistake you can make is to think that ‘it can’t fall any lower’. Learn to be patient and stay away during down trends. Buy only after an up trend is re-established.

A beginner’s guide to stock investing – a guest post

Most new investors jump into the market when the Sensex is near a peak, and there is a feeling of euphoria all around. That is precisely the wrong entry point. Investors tend to shy away from the stock market when bears are on the prowl and even well-known and well-established companies trade near 52 week lows.

Nishit feels that bear periods are great times to do your homework and get ready for entering the market once things improve. In this month’s guest post, he explains the steps that novice investors can take for building wealth through stock market investments.

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I often face this question from my colleagues: How do beginners begin investing in stocks? The fear factor is what prevents many people from investing. The first step is often the most difficult one to take to start as an investor.

One of the first things to do is to start small. Start with a capital which you can afford to lose. The ‘tuition fees’ are needed to be paid to the markets. Till one actually invests (and loses some money), one cannot get a feel of the markets. Now that one has earmarked a small sum to play with, the next step is to identify a decent online brokerage. Most of the novices are normally fixated with the amount of brokerage one has to pay. That should be the least of one’s concerns. Remember you are an investor, not a trader. Best is to stick to some big player like ICICI Direct or HDFC Securities.

So, we have allocated funds and have an online account in place. What next? Now comes the most interesting part. Nothing beats reading. While your account is being opened, do start reading. Read the Economic Times daily, and the Hindu BusinessLine on Sundays. There are several good books for reading, like Beating the Street and One up on Wall Street by Peter Lynch; Rich Dad, Poor Dad by Robert Kiyosaki. Once one has read up a bit, one can read the grand daddy of all investment books, The Intelligent Investor by Benjamin Graham.

When buying a stock, make sure you are clear in your mind about why you are buying the stock. Start off by buying blue chip stocks. Remember if one makes losses initially it may put off the investor from investing for a lifetime. Stock picking is a fine art and one improves with time.

Also, start of by visiting blogs and websites like www.equitymaster.com to get a feel of the markets. Make sure you review your portfolio once a week. A portfolio should contain about 5-10 stocks. Next is keep track of earnings and news related to one’s stocks by visiting www.nseindia.com

Often, the process of seeing a blue-chip winner is more interesting and satisfying than the actual profits one makes. Each of us is a specialist in the field where we earn a living. Start off by exploring stocks in your area of competence. A doctor could explore Pharma stocks, an IT engineer the software companies, and so on. Also, ask your friends and relatives about companies in their domain of expertise.

The housewife is one who has a vast circle of competence. She knows which items are popular in the grocery store and can look at investing in those companies.

Those folks who find doing all this cumbersome and boring, mutual funds are the easier way out. HDFC Top 200 is a blue chip fund with a portfolio of good companies which has returned compounded 23.58%, which means Rs 10 invested in 1996 is now Rs 196. 20 times returns in 15 years. In this case, sit back, relax and enjoy your life.

For all Mutual Fund Investors, www.valueresearchonline.com is the mother of all sites. One can research one’s fund here and invest.

To create wealth, stock market investment is a must. It is not rocket science and even the lay person with a bit of reading up can become an informed investor.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Is the recent stock market volatility unusual?

Before I answer that question, let me try and explain what volatility in the stock market really means. To the ordinary investor, volatility may mean sudden and unexpected changes in a stock’s price (or an index level).

But aren’t fluctuations in stock prices and index levels the norm rather than the exception? That’s an easier question to answer. Yes, stock prices and index levels do fluctuate all the time. But some times, the fluctuations are tolerable and ‘normal’. Those are periods of low volatility, which are conducive for trading and investments.

At other times, there are extraordinary and nerve-wracking fluctuations in stock prices and index levels that send traders and investors scurrying for cover. Such periods of high volatility increases risk and decreases returns.

For the mathematically inclined, volatility is a statistical measure of the uncertainty or risk associated with changes in a stock’s price (or an index level). It can be measured by using the standard deviation or variance (i.e. two standard deviations) of the returns from a stock or index.

A measure of the overall volatility of a stock’s return benchmarked against an index is called ‘Beta’. A Beta value of 1.0 means the stock’s return is the same as that of the index. In other words, if the index gains 100%, the stock will gain 100%. A Beta value of 1.5 means a stock will gain 50% more than the index during bull periods, but lose 50% more during bear periods; a value of 0.8 means the stock will gain 20% less than the index in a bull market, and lose 20% less in a bear market. The higher the Beta value, the more volatile the stock.

For the technically inclined, the Nifty VIX chart indicates the implied volatility (IV) of a basket of Nifty put and call options. A high VIX level (above 30) indicates high volatility; a low VIX value (below 20) indicates low volatility. Typically, when the VIX rises, the Nifty falls. The VIX can be used as a contra-indicator. Low values give an opportunity to sell, and high values provide opportunities to buy.

What causes high volatility? Unexpected changes - in interest rates (repo, reverse repo) or oil prices; a war or terrorist attack or earthquake; a change of government - can lead to wide fluctuations in stock prices and index levels.

What can small investors do? Understand this simple thumb-rule. Volatility declines when stock markets rise, and increases when stock markets fall. In a bear market – like now – high volatility is not unusual.

That is one reason why small investors may be better off staying away instead of trying to make a few bucks on counter-trend rallies; and avoid averaging-down during bear markets.

That was the long answer. The short answer to the question is: No.

Related Post

What is causing the volatility in the Sensex?

Fool’s Four stock investment strategy

Let me first assure readers that the Fool’s Four (or Foolish Four) stock investment strategy is neither foolish, nor is it meant to make fools out of investors. It is a ‘mechanical’ investment strategy that can be useful for those investors who haven’t yet developed their stock-picking skills, and have probably lost money chasing ‘cheap’ small-cap stocks.

The Fool’s Four strategy was designed by The Motley Fool investment group as a refinement to the Dogs of the Dow strategy. I had written about the Dogs of the Dow strategy in a post back in Apr ‘10. The strategy works just as well with Sensex stocks. (If you are a recent visitor to this blog, or have forgotten what I wrote more than a year back, you may want to read the earlier post first.) 

Since it is a variation of the Dogs of the Dow strategy, the Fool’s Four involves selection of four stocks from the Dow index (or Sensex) based on low price and high dividend yield. The dividend yield is calculated by dividing the actual dividend per share in Rupees (not the percentage dividends usually announced) by the current market price (CMP) of the share in Rupees.

The selection process involves calculating the square roots of the CMPs, and the dividend yields of each of the 30 Sensex (or Dow) stocks. Next, divide the dividend yield by the square root of the CMP to find a ratio for each stock. Then rank the 30 stocks based on a descending order of ratios (i.e. the stock with the highest ratio will have a rank of 1, and the stock with the lowest ratio will have a rank of 30).

If calculating the square roots of the CMPs is too much of a challenge, you can calculate the square of the dividend yield (multiply the dividend yield by itself) and divide it by the CMP. The ratios will be different, but the rankings will be the same.

Now comes the interesting part. Drop the stock with the rank of 1, and choose the next 4 (ranked 2 through 5). Buy equal Rupee (or Dollar) amounts of each of the short-listed four stocks, and hold them for a year. Why drop the stock with the number 1 rank? There is a good possibility that it may be in financial difficulties. Sensex (or Dow) stocks are supposed to be financially stable, but the odd JP Associates do get in trouble by being over-ambitious.

Is there any logic behind the Fool’s Four strategy, or is it just some foolish number crunching? Apparently, academic studies have proven that (a) high dividend yield leads to better market performance (which is the logic behind the Dogs of the Dow theory); and (b) stock price variations (or ‘beta’) is correlated with the square root of the price.

So, the Fool’s Four strategy gives slightly better results than the Dogs of the Dow (or Sensex) strategy. That doesn’t mean that all four stocks will beat the Sensex. The underperformer(s) should be replaced by stocks from the short-list of four selected next year. The Sensex-beaters can be retained.

(Note: Interested readers can do the exercise of selecting the four stocks from the Sensex that meets the above selection criteria. I’ll post their brief technical analysis once I receive your feedback. Then we can check back after one year and see how well the strategy works.)

How many shares of each company should I buy?

A common question vexing many small investors is how many shares of each company to buy. A young investor friend did quite a detailed analysis of a particular company, and took some inputs from me to fine-tune his analysis process.

After a few iterations to arrive at a proper valuation, he decided that the current price had enough ‘Margin of Safety’ and decided to buy the shares of the company. How many shares did he buy? 100. Nothing wrong with that. Small investors can’t always spare a lot of cash.

What happened next? Within a short time, the stock spurted on large volumes and doubled in price. My friend was left ruing the fact that he didn’t buy more shares even though he had spare cash. Shortly thereafter, the company announced a bonus issue, and the stock spurted even higher.

In spite of doing due diligence, a big money-making opportunity was lost because a sufficient quantity of shares were not purchased to start with. Such opportunities don’t come often. So, how do you decide what is a ‘sufficient quantity’?

In last Tueday’s post: How many stocks should I buy?, I had outlined how a Rs 5 lakh portfolio can be allocated to large caps, mid caps and small caps. The suggestion was: 8 large caps worth Rs 50,000 each, plus two mid caps and two small caps worth Rs 25,000 each.

While the money allocation to each category of stocks would automatically limit how many shares of each company you can buy, it won’t eliminate the risk factor. Different investors have different risk tolerance levels, and that should be built into the allocation.

Here is a simple example. Suppose you decide that the maximum loss you can afford in the large cap stocks is 5%, and 10% in the mid and small cap stocks. Your large cap allocation is Rs 50,000 to each of 8 companies. Your mid and small cap allocation is Rs 25,000 to each of 4 companies. A 5% loss in the large caps and a 10% loss in the mid and small caps would limit the loss to Rs 2500 per stock.

(If all your picks fail to perform and hit the respective stop-loss levels, your total loss will be limited to Rs 30,000; i.e. 6% of your Rs 5 Lakh portfolio.)

If you decide to buy a large cap with a current price of Rs 100, you can buy 500 shares with a Rs 5 stop-loss to ensure that you limit your loss to Rs 2500. What if a mid cap is trading at Rs 100? Should you buy 500 shares in that case?

Since mid caps tend to fluctuate more, you had chosen a 10% loss as your limit. That would mean buying a Rs 100 stock with a Rs 10 stop-loss. Buying 500 shares may incur a loss of Rs 5000 if your stop-loss is hit. So, you need to buy only 250 shares with a Rs 10 stop-loss.

The example is simplistic to make a point. You need to adjust stop-loss levels for each stock that you buy according to your comfort level and the beta value (i.e. the amount by which a stock fluctuates with respect to an index) of each stock.

How many stocks should I buy?

From the emails I receive from readers and newsletter subscribers, this is a common question faced by many small investors. Due to limited resources, investors tend to swing from one end of the buying pendulum to the other. They either buy 30 shares of a fundamentally strong stock trading at Rs 500; or, they buy 500 shares of some unknown small-cap trading at Rs 30.

Both can be counterproductive for the growth of your portfolio. With the costlier stock, a sudden spurt to Rs 600 may tempt you to sell out quickly and miss a bigger profit opportunity. The alternative strategy of booking partial profits and holding the rest with a trailing stop-loss may not work too well with only 30 shares to play with.

For the less expensive stock, a 20% gain from 30 to 36 may not seem enough to do any profit booking. So you hold on with the hope of selling only if the stock reaches 50 – which it may never do. In fact, the cheaper stock is more likely to drop to 15.

What is the solution? Firstly, you need a decent amount of capital to build a portfolio of individual stocks. I recommend a minimum of Rs 5 lakhs – preferably Rs 10 lakhs. What if you have only 1 or 2 lakhs? You may be better off investing in mutual funds and fixed income instruments to build up your capital.

What if you do have Rs 5 lakhs? How do you decide how many stocks to buy? The thumb rule in buying individual stocks is: More is not merrier. Keeping regular track of any more than 10-12 stocks can become a full-time activity. You have to remain informed about the overall economy – local and global, individual sectors to which your stocks belong, quarterly performance of individual stocks as well as news flows about them; read Annual Reports; check if dividends are getting credited; apply for rights shares, and a myriad other things.

If you settle on 12 stocks for your portfolio, how will you allocate to large, medium and small-caps? A thumb rule for getting steady returns, protecting downside during bear attacks, plus having a growth ‘kicker’ is to allocate 80% of your capital into stalwart large-caps, and 20% to good mid-caps and small-caps.

How many stocks in each category? Say, 8 large-caps, 2 mid-caps and 2 small-caps. Allocating Rs 50000 for each large-cap, and Rs 25000 to each mid-cap and small-cap stock will complete your portfolio. This is a suggested portfolio. You can tweak it to suit your own style and risk tolerance.

Once you limit yourself in terms of the number of stocks and the allocation of capital to each stock, a funny thing will happen. You will be forced to be very selective about the stocks you pick. That will, in turn, make you more disciplined about choosing the very best stocks – and waiting to buy them only after a significant price correction.

The same Rs 500 stock mentioned earlier was probably trading at Rs 200 two years back, and may drop to 350 after the next correction. Instead of buying 30 shares now, buy only 10 (to help you to track it regularly). When (and if) it drops to 350, buy 130. You will end up with 140 shares and complete your Rs 50000 allocation to the stock.

Related Posts

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Why building a stock portfolio is like buying a car

Some strategies about buying stocks

In a post last week, I had discussed strategies for selling stocks. Most small investors know how to buy stocks, but they rarely have proper strategies for selling. So why am I writing about buying strategies?

From the spate of questions I have recently received about when and how much to buy, it seems that discussing some buying strategies may be useful after all. I had mentioned about using the ‘Margin of Safety’ concept and P/E bands to decide entry points in last week’s post.

The importance of those two concepts can’t be over-emphasised. Too many young investors follow the wild west policy of ‘Shoot first, and ask questions later’. Just switch on any business TV channel (just for entertainment) during the day when they take reader queries. 99% of the questions are: ‘I have bought thus and such stock at this price; should I hold or sell.’

It is apparent from the questions that the stock was bought near a top, and the investor is already sitting on a loss. The question – or rather, a plea – is to find out if the TV expert knows some magical formula by which the loss can be quickly turned into a profit, or, at worst, break-even with no loss.

All one has to do before placing a buy order, is to first check whether the current E/P (i.e. inverse of the P/E ratio) is higher than the long-term bank fixed deposit rate, leaving a ‘Margin of Safety’ . Also check that the debt/equity ratio is less than 1, and that the cash flow from operating activities is positive for 4 of the last 5 years.

If E/P is lower than the bank FD rate, then check the P/E band within which the stock normally trades, and buy only if it is available near the middle of the P/E band or lower. These are basic precautions, and will help prevent losses – even if you don’t have the time or inclination to do a detailed fundamental analysis.

If you are like most small investors, the stock price will fall just after you’ve bought it (and, it rises soon after you sell)!! What should you do? Do not, repeat, do not average down. That is the single cause for turning a small loss into a much bigger one. Instead, keep a stop-loss – and sell if the stop-loss is hit on a closing basis (i.e. take intra-day movements out of the equation).

You will make much more money by averaging up. When should you do that? Buy 20-25% of your intended quantity at the beginning. Add more every time the stock dips or corrects on the way up. Follow a ‘pyramid’ strategy – i.e. buy less and less quantity on the dips as a stock keeps moving up in price – till you acquire your intended quantity.

Such a strategy will prevent impulsive buying of 2000 or 5000 shares in one go, in the hope of becoming a Warren Buffett within a month. Talking of Buffett, I love his quote: ‘You can’t make a baby in one month by getting nine women pregnant!’

Wealth-building takes time. If you hone your buying and selling strategies, you have a chance of becoming wealthy in 15-20 years – but not in 15-20 months.

Some strategies about selling stocks

Why discuss stock selling strategies just when the Sensex is showing some signs of life after an 8 months long corrective move? Isn’t this a good time to buy and make some money?

The answer depends on what type of investor you are. If you want to play the momentum in the short-term, by all means buy and book profits after a gain of 3 or 5 points. May be even 8 or 10 points. Which isn’t bad at all – if you are trading thousands of shares. Such a strategy can be followed at any time.

But many small investors don’t have big money at their disposal. They can buy 200 or 500 shares at a time (I’m not talking about penny stocks here). A 5 or 10 point gain is neither here nor there – compared to the risks involved. May be this isn’t such a great time to buy after all – since the index is just about 10% below its all-time high.

Instead of having an ad-hoc hit-and-miss strategy, have a plan. For buying, holding and selling. The ‘Margin of Safety’ concept works well for buying. P/E bands work well too – for buying, holding and selling. I prefer to use an asset allocation plan for timing buy-sell-hold decisions.

Today, I want to discuss a few selling strategies. Before you buy any stock, decide on a selling plan – based on your risk tolerance, time horizon and individual preference. As a long-term investor, I prefer to have a three years time horizon for any stock to perform. You can just as well choose a one year or two years time frame. Anything less than a year, and you will be treading the fine line between an investor and a speculator.

Once you decide on a time frame, pick a realistic price point. 100% gain in 1 year may happen once or twice, but is not a realistic goal. But a 50% gain in two years, or a 100% gain in three years may be more achievable. When the price target is reached, it is best to sell out entirely. But if you feel that more upside is left, book partial profits, and hold on to the rest with a trailing stop-loss. If the price target is not reached, don’t hold on with the hope that it will be reached ‘some day’. Just sell.

If by partial profit booking you have withdrawn your original investment, don’t ever think that the balance holding is ‘free’. It isn’t. It has an opportunity cost. If the market dives and your balance holdings drop by 50%, you have lost real money. A trailing stop-loss will save you from such a calamity.

Supposing you have a two years time frame with a 50% appreciation target. After six months, the stock suddenly starts to flare up and gains 50%. What should you do? Wait for your two years time frame, or sell now? Sudden flare-ups in stock prices occur for different reasons - insider buying, some company-specific news that you may not have heard yet, a fundamental change in the sector, a merger or acquisition.

Why bother with reasons? If your target is reached, sell – even if it means paying short-term capital gains tax. After all, tax is paid from profits – so you are still ahead.

So far, I have discussed selling strategies when your stock is in profit. What if you buy a stock and it keeps falling down? Have a strict selling strategy – a 3% or a 8% or a 15% stop-loss, depending on the type of stock and the planned period of holding. Have the discipline to sell as soon as the stop-loss is hit on a closing basis.

Learn to be unemotional and unexcited about your buy-sell-hold decisions. Treat them like any monetary transaction – like buying a cup of coffee or getting a hair-cut.

Related Posts

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Notes from the USA (Jun 2011) – a guest post

One of the best ways to find out about the true state of financial health of a company is to scrutinise its cash flow statement. The Profit and Loss statement is based on the accrual system of accounting. The cash flow statement records the actual inflows and outflows of cash, which provides a better idea about the sustainability of a company’s business model.

What about an investor’s cash flow statement? Are you keeping track of exactly how much cash inflow is being generated by your cash outflows (i.e. investments)? Specially in a sideways or sliding stock market? In this month’s guest post, KKP shares some of his thoughts on the subject.

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Lets Get Down to Cash Flow Analysis

Q1 and Q2 2011 have shown that there might be a good size recovery, giving a feeling of hope to many people in the US, as well as corporations. The economy has slowly been recovering – no doubt. But the housing and construction market rebound has remained soft despite the big QE (quantitative easing) programs from the Fed and the low-low-mortgage rates (average 30-year fixed U.S. mortgage rate is around 4.82%). The reason is simple: Stubbornly high unemployment and underemployment, and also tight lending policies from the bankers/lenders. Bankers have swung the pendulum to the other end of the spectrum and have very stringent policies. In 2002-2008, lenders would lend money to people without any money down (by doing double mortgages), and today, even if someone is providing 25% down payment (upfront cash), they are scrutinized as if they are one of the worst borrowers.

Predictions show that home prices will fall around the 5% to 10% in 2011 compared to 2010, and they will remain flat in 2012. This median forecast was part of a poll by Reuters of 21 economists who provided price forecasts. In looking at really long term trends of US home prices, it clearly shows that home prices are close to the bottom and will hover around here for a bit, and with a ‘core-recovery’ we will see a bounce up in prices (albeit very slowly).

"It is hard to see the housing market doing better until the massive headwind of foreclosures is removed and that will likely take a couple of years," said Mark Vitner, senior economist at Well Fargo Securities in Charlotte, North Carolina. With home prices still falling, many potential buyers are sidelined and banks are more stringent with loan applications and credit scores, Wells Fargo's Vitner said. "It is not that I am pessimistic about the housing market, it is just that I am not optimistic and a gradual recovery probably will not happen until 2013 or 2014, with a full normalization not until 2015," he said.

I have noticed that there is a rise in the "distressed, foreclosed and short sale" homes due to the fact that the lower home prices have put mortgage balances (what you owe on the home) above the current price of the home. Therefore, the home either goes into a short sale (seller and lender put it on the market), or foreclosure (owner cannot or will not pay mortgage), or distress situation (seller does not pay mortgage, and lender cannot afford to keep the home on the books). The net result is that the price of the home has to be marked down significantly, for investors or home-upgraders or renters are willing to look at the properties.

I am currently sprucing up a home that I purchased as a ‘distressed home’, and will be renting it out before July 1^st, 2011. In addition, have offers out on Short Sales where the Seller and Lender are considering my offers for Downtown Condos (at 1/3^rd to 1/4^th the last sale price). Even with the above flat market situation predicted, I remind myself that I am buying real estate at the “equivalent of March 2009 Sensex prices”. Remember how undervalued we were in the stock market at that time, before we took off? Real estate will NOT take off in the same manner (of course), but my tarot-charts (figuratively speaking) is telling me that I am buying it close to the bottom and have no desire to price these out for sale since I will be renting them out in the near term (2 to 5 years).

In addition, I am buying these at really ‘distress’ prices, instead of chasing them, and have the ‘patience and privilege of dividends’ while I hold. Dividends are in the form of rent here so it is easy to convince myself to hold. So, equate it to holding a stock that may not move up immediately, but will pay you almost risk free 12% to 26% in return with minimum loss of capital (if so).

Bottom line is that a lot of books have been written about ‘cash flow’ production, and with this methodology, I have found how much of a parallel it holds to Selling Calls on individual stocks being held in a portfolio. Call Selling had been a very favourite methodology of mine when I was very active in the markets in the 1990’s, and most recently as a way of reducing my stock holdings. But, in both cases, it taught me how to ‘generate cash flow’ from the holdings, and ‘make a paycheck’ out of it.

Real estate has the power to make the same with almost the same amount of time involvement. Wow. Really? Yes, very true. In India, it is even better since you can literally buy a flat/condo and rent it out, making all responsibilities of maintaining the flat a responsibility of the tenant (minus big issues). I am able to replicate the same with a team of contractors to simplify my life and do virtual-maintenance (call someone to go and fix it at low cost).

For now, think cash flow, and figure out a way to generate a paycheck or cash flow from your investment holdings. If you hold RIL or HUL for a long time, the percentage yield to your purchase price could be significant enough to get a very net high yield, especially if the stock has provided splits/bonuses. With my net-buy-price of HUL under Re 1.00, the percentage yield on the annual dividend seems like a paycheck each time it comes. So, there are many ways to skin the cat, and as one gets more experienced, some of these techniques become part of the portfolio and life, and yet, it is each portion of the portfolio that needs to replicate the ‘cash flow’ generation methodology. Traders might be good at generating cash flow from ‘trading’, but very few can do it consistently, and hence doing it with many techniques/strategies will be good for your long term financial health.

Hope you can ‘draw’ some ideas from this to your thinking and add a twist to your investments that might change the overall short and long term return, such that it gives back some cash flow which can help with your own personal goals (buying gold or silver)…..Oh, that brings me to another favorite topic of mine (gold), but we will leave that for the future….

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Why small investors should avoid ‘cheap’ stocks

There are several reasons why small investors should avoid ‘cheap’ stocks, and I will take them up one by one. Before that, one must understand what is meant by ‘cheap’ stock.

Investopedia.com has the following definition:

“The illegal practice of issuing stock options at artificially low prices shortly before an initial public offering. Often underwriters will require a company to have more qualified management before they can go public. They attract these qualified individuals by giving options with a low exercise price.”

This was a practice which was prevalent prior to and during the dot.com boom in the USA, and is not unheard of in India. While it can lead to significant profits, the average small investor won’t be able to participate - unless his uncle or friend’s father was the promoter of the company. If a company is trying to sell its stock through bulk SMS and email messages at a lower price than its forthcoming IPO price, chances are that it is a ‘dud’ company and best avoided.

Then there are those companies that were the apple of investor’s eyes during the previous bull market, and reached stratospheric levels just before the crash in Jan 2008. Real estate stocks were at the forefront, followed by the stocks with the word ‘infrastructure’ in their name. Most of these apples had rotten cores. They have not only become cheap stocks, but continue to get cheaper by the day. Don’t go anywhere near them.

There are cheap stocks which are also called ‘penny stocks’ because they trade below Rs 10. Most of them are unknown, fraud companies who have no business and no intention of doing any business. Occasionally they boost up their share price from Rs 3 to Rs 8 by planting fake stories in the media about the great opportunity for investors once they dismantle the fourth rate defunct plant that they have bought in Uzbekistan or Burkina Faso and reinstall the plant in Jhumri Tilaiya. Avoid such stocks like the plague.

Some cheap stocks may appear cheap, but are not. A Re 1 face-value stock trading at Rs 15 is equivalent to a Rs 10 stock trading at Rs 150. A Rs 10 face-value stock trading at Rs 15 may not be cheap either, if it belongs to a loss-making company, or one that is trading at a P/E of 80 or 100. Stay away from such stocks.

What about stocks that appear relatively cheap with P/E ratios below 15 that generate strong cash flows from operations, have low debt/equity ratio and double-digit profit margins? Ah-ha, now we are talking. I just love to dig and find such stocks. They are the ones that will give a nice boost to your stock portfolio’s performance.

What small investors can learn from my trip to the bank

Thanks to the technological innovations of debit cards and credit cards, my trips to the bank have become few and far between. So, on the rare occasions that I do visit a bank, I’m pleased to see lots of eager, young faces looking busy and ready with a smiling ‘Can I help you, Sir?’ welcome.

The initial good feeling soon turns to exasperation. I had gone to get a copy of the account statement for March ‘11 that I had misplaced. A pretty young lady said it would only take a couple of minutes, and would I mind the wait? Not at all, I assured her. That is when things started going wrong.

First, she wanted to know my account number. Since I didn’t remember it, I gave her the April ‘11 statement copy. My daughter’s name appeared as the holder. So, the next question – without even checking that I was the second holder – was, who do you bank with? I mentioned the name of two competing private sector banks.

She had taken a look at the account balance, and came up with: Can we help you with your investments? I said, no thanks. By this time, a bright-looking male colleague came to inform her that the printer was down and the statement will be couriered to me. But he had overheard our conversation and decided to jump into the fray with: Have you thought about a SIP in a mutual fund?

I was already feeling irritated because the trip to the bank had been a waste of time. So I mentioned my preference for investing in stocks and asked him whether he had started a SIP. He proudly announced that he invested 20000 in a SIP every month, and explained how his holding cost will average out over the ups and downs of the market.

Had he thought it through, or was he merely repeating what he had been taught? It was his turn to be irritated. Simple arithmetic, he scoffed. When the market goes up, he gets fewer units, but when the market falls he gets more – so it averages out!

Had he done the arithmetic with real data? Did he know that bull markets tend to last 3 to 4 times longer than bear markets? Therefore his average holding cost is likely to rise over time? Now he didn’t look so confident. So he tried a different tack – not willing to pass up an opportunity to ‘cross-sell’.

Had I thought about investing in a private equity fund? I told him that SIPs and private equity funds are thought up by fund managers to help the fund and their own pockets. They don’t benefit the investor to the same extent.

He made another effort: A competing bank has made a ton of money by floating three private equity funds. I responded with: Does it prove that your fund will make money? Now he played his trump card: How do I make money when the market is down – like now?

I explained that investing is not a job where one had to make money every day. If one invests in good dividend paying stocks, like TISCO or ITC, then one can earn money whether the market is up or down. ‘Every one knows ITC pays good dividends’ – was his parting shot. So how many ITC shares did he own? He had accumulated 70 shares. Instead of his SIP, why didn’t he buy 100 shares of ITC every month? No answer this time – end of debate.

The moral of the story is: Regardless of whether you concur with my antipathy towards SIPs or not, always question investing strategies – whether you have thought it up yourself, or received advice from anyone.

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How small investors can widen their Circle of Competence

Warren Buffett is a strong believer of the Circle of Competence concept. If a company or business doesn’t fall within his Circle of Competence, he won’t touch it. He famously avoided buying into any high-tech company in the 1990s – when every one and his brother-in-law were investing in dot.com companies. He didn’t understand how high-tech companies were making money, and whether they had sustainable businesses. He missed the boom – and the inevitable bust that followed.

Warren Buffett is one of a kind. You and I will never be able to match his skill and wisdom in investing. That doesn’t mean we shouldn’t follow some of his money-making principles. What if our Circle of Competence is too limited? Is there a way to widen the Circle?

Let me give you the bad news first. You can’t widen your Circle of Competence in a hurry. It is a process that will take a lot of time and effort. The good news is that the process is not difficult or complicated. It takes patience, perseverance, and a plan.

First make a short-list of all the knowledgeable people you know. The list isn’t likely to be a long one if you are looking for people with real knowledge. Not some one who knows how many hundreds Tendulkar scored before the age of 25, or the exact locations of the seven wonders of the world. But some one who knows about the economy, business and industry.

Next, figure out how you can meet such people without imposing too much on their time and patience. May be he is a friend’s father or your wife’s uncle. If you inform them in advance that you want to meet them, and the reasons for the meeting, knowledgeable people will be more than happy to share some of their experiences.

Don’t know anyone knowledgeable enough? Join discussion forums and investment groups. There are many in cyberspace. Each group or forum will have a few knowledgeable members. Try and pick their brains.

Going to a family wedding or a party? Don’t just waste your time eating and drinking and being merry. Introduce yourself to people you don’t know, and find out about what they do. If you show genuine interest in their activities, they will give you a lot of information that you won’t find in TV channels or pink papers.

Carry on this process for some time, and you will be amazed at how much wider your Circle of Competence can become. Then, have the discipline to stick to your Circle of Competence when choosing stocks to buy. That will prevent you from getting badly stuck in the shares of a company that you really know nothing about. Like Suzlon, or Punj Lloyd, or Bartronics.

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What is your Circle of Competence?