Perils of Timing the Market

Time and time again, we’ve been emphasising the importance of NOT timing the market. It is the time (duration of your investment) and not timing that matters. Despite investment masters and experts highlighting the futility of timing the market, the average investor (and many Investment Advisors too) always think that somehow he would be able to outsmart everybody and time the market.

As legendary investor and one of the most famous investment guru, Peter Lynch points out “Thousands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.”.

Still a whole set of advisors and traders thrive on the concept of timing the market and make money for themselves, if not for their investors. I would like to quote excerpts from one of my earlier article on ‘Perils of trading in the market’.

Stock Market is a giant casino.

Surprised that this statement comes from an investment advisor who invests in stocks and equity funds and who also advises clients on the same. Let me explain.

More than 90% of the people in stock market treat it as a Casino and so it gives results accordingly to them. In a Casino, who earns? As you are aware, Casino is a zero sum game. The only guy who earns consistently in a Casino in none but the Casino Owner. Likewise since most of the people in stock market treat it a like a Casino, the only guy who consistently earn here is none other than your stock broker who keeps providing you almost daily trading tips.

If 90% of the people in market only continuously speculate and trade in market and end up loosing money in the long run, why are they doing it? This is similar to why someone is a smoker or alcoholic or drug user knowing fully well it is injurious to health. The answer is addiction! Like wise, for the speculators and traders in the market it is an addiction for continuous action. This continuous action only makes their adrenaline flow.

That is why the world’s greatest investor Warren Buffet says” Never ask the barber if you need a haircut. There’s very little money to be made (by a broker) recommending our strategy of buy-and-hold. Your broker would starve to death. Recommending something to be held for 30 years is a level of self-sacrifice you’ll rarely see in a monastery, let alone a brokerage house.”

As Personal Finance legend John Bogle points out,the way to wealth for the stock brokers is to persuade their clients and say ” Don’t Just stand there. Do Something”. But the way to wealth for the clients is the opposite maxim ” Don’t do something. Just Stand there.” This is the only way to avoid playing a looser’s game.

Stock or an equity mutual fund is not a lottery ticket. It means that you are part owner of a corporation (as in the case of stock) or corporations (as in the case of equity mutual fund). Roughly only 10% of the people who are involved in the market think on those lines. They are not worried about every day stock price movements. All they care is whether they are invested in a company which is continuing to grow or invested in a diversified fund which is a consistent performer and is able to beat the Benchmark returns. Their typical investment horizon is 10 to 20 years or more and the barest minimum period they look for equity investment is 5 years. Only this 10% would have earned the annualized return of 18% provided by the Sensex in the past.

For a trader, few weeks to couple of months itself a long term and for an investor, as I mentioned above 10+ more years is only long term.

Please read the book ‘Fooled by Randomness’ by Nassim Nicholas Taleb. You would get more insight on the issues I’m speaking above. Less than 5% of the traders ever make big money in the long run and the remaining 95% are complete loosers. If you are a long term investor, in a growing economy like India, the chances are almost close to 100% that you would make good money in the long term.

Would you want to be an investor or trader? Would you want to be in the 90% looser’s category or 10% successful category?

I want my clients to be in the 10% successful category who makes good money in the long term, who do not worry about short term volatility, do not track the stock prices and NAV on a daily basis and see where one stands. Once you a take a short term perspective, greed or panic would set in and you would end up being like a casino player. Market rewards people with patience and extreme emotional discipline. But be sure that the reward is worth the wait.

But we should also be thankful to these speculators and traders. Because of their greed and panic they keep providing us periodic opportunities to keep rebalancing our asset allocation and build our wealth. To explain, you should always follow an asset allocation. How much of your financial assets you want in Equity (Shares, Equity Funds) and how much in Debt (FDs, Postal deposits, Debt Funds etc.). When due to their greed speculators keep raising the shares to the extraordinary levels, your equity as a percentage of financial assets would go up. Then book some profits and put more in debts. When due to their Panic when speculators sell heavily and stocks are available at dirt cheap prices like now, your equity as a percentage of financial assets would go down. Then move a portion of your debt into equity by investing in shares / Equity Mutual Funds. This has been put more succinctly by Dhirendra Kumar in the following paragraph.

“One of the more interesting ideas in asset allocation is to change the balance according to market conditions. The concept is that over medium to long terms, equity markets inevitably move in cycles. There is a part of the cycles where equities are clearly underpriced and there are parts of the cycle when equities are clearly overpriced. In the former, one should give more weightage to equities and in the latter, less weightage. Then, as the markets go through their cycle, the investor will be best able to capture an optimum level of safety with that of returns.”

By the suggestion I’ve mentioned above, you may not get the maximum returns from the market, but would definitely get a very decent return with optimum level of safety.

I’m a champion of long term ( 10 to 20 years) investments in markets especially through SIP (Systematic Investment Plan). As your corpus in SIPs keep growing and once exceeds the asset allocation ratio, we can continue to rebalance your asset allocation by infusing the fresh money into debt funds. For people who do not have fresh money to infuse at that time, a part of the equity holdings can be sold / redeemed and moved into debt funds.

There is no point in reviewing asset allocation too frequently. Some people even look at it daily !!!. Once in a year is sufficient to review and rebalance the asset allocation, if required. Considering our tax laws, yearly rebalancing would be more tax efficient too.

Equitymaster’ s chart explains (source: Trend) how timing the market is at your own peril.

“The markets seem to be on a downward path. I will invest only when they start turning positive”. This is a standard argument given by most investors when asked to invest in a falling market. In fact, I’m amazed how many novices think that they are great investors. These investors believe that they could time the market to perfection and hence, investing in a falling market makes no sense. However, expert after expert has gone on to say that trying to time the market is a fool’s game and should be avoided at all costs.

During the last ten year period, if an investor would have missed out the ten best days in the stock market, a sum of Rs. 100,000 would have returned a puny Rs. 133,592 as opposed to Rs. 349,256 had he stayed fully invested.

Your investment of Rs.100,000/- invested ten years before in Sensex is worth following (Data Considered: Sensex closing between 5th August 1999 and 5th August 2009)

Remain Invested – Rs.3,49,256/-
Missed best 2 days – Rs.2,68,775/-
Missed best 4 days- Rs.2,14,702/-
Missed best 6 days- Rs.1,81,304/-
Missed best 8 days – Rs.1,49,496/-
Missed best 10 days- Rs.1,33,592/-

Even missing the two best days would have lowered his final figure by a significant 23%. The moral of the story is that it pays to remain invested for the long haul rather than trying to move in and out of markets in an attempt to try to time them.

So please be an investor and not a trader. Then you would never fail in stock market and would end up building a substantial wealth.

As I indicated above, it needs enormous emotional discipline to be an investor. I wish that all of us develop the same and reap excellent rewards which Indian stock market is waiting to offer.

(Inputs: Equitymaster and my earlier article)

The Real Estate Bubble

 

I’m thankful to people who have enquired why there is no article from me for the last 3 weeks. This shows your interest in my writing which is what motivate me to keep writing. I was not keeping well on and off for the last 3 weeks and that is the reason for my inability to write.

 

I got a good response for the article ‘South Sea Bubble’, in which none other than even Sir Isaac Newton last money. This shows stock market booms and bursts have been existing for centuries and there is nothing new about it. Every time a Bubble happens, a new set of investors learn some very old lessons.

 

Lot of people in our country think that ‘Real Estate’ Markets do not come under the cycles of boom and burst and there is an ingrained belief that the value of one’s property always keep only going up. Nothing is farther from truth than this cultural belief of ours.

 

Infact the current global financial crisis and recession started with the burst in the U.S. Real Estate Market. That market burst because every one who have been buying house on leverage (debt) thought that his house value will only keep going up  and will never come down.

 

Do you know that Real Estate prices in Dubai has fallen so drastically that the properties in a well developed city like Dubai is now cheaper than the property values quoted in Mumbai? 

 

Please read the below article for an interesting real estate bubble which happened in U.S. around 100 years ago!

 

” At the heart of the subprime crisis was the belief that house prices would continue to rise without any risk. This is not the first case of real estate bubble in the US. In fact, a huge real estate bubble developed in the US during the early twentieth century. That infamous bubble is known as “The Florida Real Estate bubble of 1920.”

 

In the early 1920s, Florida entered a period of frenzied real estate speculation. At that time, the US was bustling with economic activity and it created a sense of delusion among people that such prosperity was infinite.

 

The real estate market of Florida became the centre of the real estate story in the US. It became a popular destination for people who preferred its tropical climate. Population started growing steadily in Florida and housing couldn’t match the demand. This in turn resulted in price escalation in the real estate market. Land prices quadrupled in less than a year.This swift movement of prices in the region attracted a lot of speculators. These speculators began to buy and sell land for small profits within a short span of few months.

 

The story of Florida started spreading across the country and people poured into the state eager for quick profits. It is said that during this time everyone was either a real estate investor or a real estate agent in Florida.

 

Very soon windfall profits began to escalate to unsustainable levels. At these levels it became difficult to find new buyers to flip properties at huge profits by speculators. By the beginning of 1925, investors started reading negative articles about Florida investments.

 

Forbes Magazine warned that the prices of lands in Florida land were based only upon the expectation and not upon any reality. At the same time bankers from New York and other regulatory agencies started investigating and scrutinizing the Florida real estate boom. Eeverybody started seeing the writing on the wall, and panic started creeping into investors and then selling ensued.

 

The inevitable bursting of the real estate bubble had begun. With sellers outnumbering buyers, prices fell like a stone. The Florida land boom was officially over as the Great Depression began.

 

Benjamin Graham once quipped “Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble… to give way to hope, fear and greed.”

 

Asset price bubbles are part of every market. They do not happen overnight. These sharp upward moves are generated by a major shift in market psychology. This can come about by any kind of stimulus in the market. Investors begin to see the growth potential in a sector and invest large amount in a particular asset class. Subsequently, the media starts covering the action. This generally triggers massive interest from the public and retail investors begin to trip over themselves to get a piece of the action. This ultimately catapults prices in the market to unsustainable levels.“

 

(with inputs from Equitymaster)

 

The Mother of All Frauds

In my recent article, I’ve mentioned about how a U.S. Fund Manager killed himself due to the Bernie Madoff scam. The more I read about the scam, I’m convinced it is the mother of all frauds due to sheer size of the money cheated. The amount involved, USD 50 Billion is larger than individual GDPs of 110 of the 190 or so countries in the world. The person who cheated was a guy with immense reputation in wall street and was also a former chairman of NASDAQ Stock Exchange. I’ve read an article written by Dhirendra Kumar in this regard and thought of sharing the same with you. He also asks people maintain a healthy distrust for Financial intermediaries.

 

Before going to that, I’ve told you in previous instances that I wanted to write about how expensive your life insurance products are, how much commission and other benefits the agent is making and so on. Last month I wrote an article kept it in draft for few days and deleted it. Because I’ve included not only the exploitation on Insurance but even on other products like Mutual Funds etc. by certain unscrupulous distributors. Being an ‘insider’, I’m aware of all the malpractices many advisors adopt for making quick bucks. I thought that since we are honest and our clients are getting right advice through us, what is the need to expose those unfair practices, end up as a whistle blower and earn the ill will of some people in the community. Three things made me to change my mind.

 

1) My Primary objective is to create Financial Literacy and help people in becoming Financially Independent – so writing such an article would be an eye opener and as and when they deal with any financial intermediary, it would help them to be vigilant.

 

2) I’m in the course of reading the first ever authorized Biography of Warren Buffett published recently. In that I read that in 1999, he was invited to Sun Valley to meet and make a presentation to the top Honchos, Investment Bankers & Managers who manages trillions of dollars and drives the global economy and also the Czars of Technology Era.  In short, he was asked address the few people who decide the fates of billions of people. During that time, he was hugely criticized by Investment community and Media for missing the Technology & Dotcom Boom. In his speech, he very analytically and logically makes a presentation as to how they have all got the picture wrong and how things would burst sooner or later (which we all witnessed in 2000). The investment community & Tech Czars who were heavily betting on technology boom (and many of them subsequently went bust in 2000) gave a standing ovation once he completed his speech, though every word in the presentation was against them. When asked how this was made possible, Buffett replied “Praise by name, criticize by Category”.

 

3) Some time ago, I wrote an article on ‘Perils of trading in the Stock Market’. To my surprise, some of my friends and students who are in the business of trading and who makes a living by making others trade, appreciated my article through mail, phone and also in person. Based on the above, I realised that people do not get offended if you lay bare facts (not accusations) and as far as possible, don’t personalize the criticism.

 

So I’ll write an article about certain unfair practices in the financial services industry some time next month.

 

Now let’s listen to Dhirendra Kumar

 

“Last week, there was this news that an investment manager in the US had, over time, made off with about 50 billion dollars belonging to his clients. The man had been running a sort of a pyramid scheme where he was paying off older clients with newer ones’ money. This enabled him to pretend to generate an excellent, steady return which was what kept attracting investors. Fifty billion dollars is a great deal of money. This swindle, if it really did involve such a sum, is very likely the biggest financial scam ever. In rupees, this is Rs 250,000 crore, which is about five per cent of India’s GDP. To put this in perspective, this sum is larger than the individual GDPs of 110 of the 190 or so countries in the world.

 

I may be wrong, but outside the US, this event has not produced a reaction on the scale that it should have. Perhaps the rest of the world has reached some sort of a fatigued state as far as reacting to financial bad news from America is concerned. News of some problem regarding a few tens billions of dollars in the US is decidedly ho-hum stuff, hardly worth the paper it is printed upon–we’re into trillions now. In terms of regulation, the United States is now officially the financial banana republic of the world, a country where apparently, anyone can steal anything from anyone. Not that Bernie Madoff was just anyone. He was a pillar of society, a member of the best clubs, former chairman of the NASDAQ stock exchange and so on.

 

Clearly, the rest of the world now thinks of a 50-billion dollar swindle in the United States in the same way as it does of massacres and mass starvation in the Congo or Rwanda or some such place. You cluck your tongue and say how terrible, but then what can you do, that’s the way things are in those parts of the world.

 

Interestingly, I’ve recently noticed some decidedly self-flagellatory articles on this subject in the US media. Just yesterday, the New York Times had this piece about why Indian banks didn’t face the kind of bubble-related problems that US ones did. The article concludes that it was the Reserve Bank’s-specifically former Governor YV Reddy’s-iron hand that held back India’s banks from rushing headlong into the kind of mess that banks elsewhere in the world find themselves in. There’s nothing remarkable about this conclusion, it’s one of those things that a lot of people in India have now realised. What is more remarkable is that an article in a major American publication saying, “The next time we’re moving into bubble territory, perhaps we can take a page from Mr. Reddy’s book.”

 

However, none of this means that financial scams are not possible in India, or that even that a Madoff-style swindle cannot take place. The remarkable fact about the Madoff affair is how simple it was. Financial regulators around the world are more focussed on sophisticated fraud. A stock broker who pockets clients’ money and simply starts printing out fake account statements in order to use the money ‘temporarily’ is much harder to guard against. Given trusting clients and rising markets, this sort of a thing is not difficult to get away with.

 

As an individual, the best way to guard against this kind of fraud is to approach all financial intermediaries with a healthy distrust and make sure that you have third-party proof of all transactions.”