Investing Myths - 1

There are many investing myths that go around as gospels and the ultimate truth in investing. As humans, if someone repeats something sensible sounding repeatedly, for a long enough period, we start believing it to be true. We then do not question its validity and take it for granted. Thats how we are.

Many of these myths are held even by professionals in the investing arena. Some are lies perpetuated knowingly or in ignorance. Some are damn lies, but statistics tell a different story!

I have highlighted a few of them. Take a look:

Myth 1:
You should buy and hold to make money.
Now, how many times have you heard mutual fund managers and other experts stating this? They have 'well chosen' examples to substantiate their claims. Buy and hold stocks for the long run and you will be rich at the end. Afterall, the logic goes, stock markets reflect corporate fundamentals, which in turn are derived from economic fundamentals. For growing economies like India, economic fundamentals in the long run remain positive.

First, how long is this long run? For most people, 10 years is long enough. Over 10 years, stocks always do well.
Or do they?

A quick look at history will reveal different results. There have been many period in the past where stocks have gone nowhere in a 10 year period.
-From 1992 to 2003, the BSE Sensex went down 33% (aggregate not CAGR). Indian GDP grew at close to 6% in real terms during this period.
-The US stock markets have shown many long periods of poor performance inspite of positive economic growth. Between 1964 and 1982, US stock markets gave a 0% return inspite of growing at a 3% real growth rate. Till date, any index investor in the USA would have got no returns for money invested in 1998, a period of 10 years gave no returns.
-The Japanese markets peaked out in 1989 and after nearly 20 years, is still down 60% from those highs.

Experts love to say that stocks should go up because GDP will grow. Not true!
-The Chinese economy is the fastest growing economy in the world, growing at breath taking speeds of 10% or so over many years. Yet its stock market went down 50% from 2001 to 2004. It is down 60% from the peaks hit last year! China might win many gold medals at the Olympics, but its stock market is perhaps the worst performer in the world!
-Someone who had invested in the Indian BSE Sensex in Feb 2000 would have got a compounded return of 10.9% from stocks till date. Not a return to die for. During this period, the Indian economy recorded a 7% real GDP growth.

Let me state this very clearly. Stocks do well in an environment of low and stable inflation and interest rates. Rising inflation and (often hence) rising interest rates are bad for stocks (USA from 1969-1982). A deflationary (falling prices) environment means economic contraction, which is also bad for stocks (Japan from 1989).

Stocks are good for the long run if your starting point is good. If you start off at the begining is a bull supercycle, stocks will give great returns. If you start off at the lower end of valuations, stocks will give good returns. If you are caught in a bear supercycle, stocks will languish.

Stocks are not always a good buy and hold asset class...No asset class is! Each asset class needs a particular environment to do well.


Myth 2:
You cannot time the market.
By this, if someone means catching tops and bottoms precisely by design (and not by accident), I agree. But this is not what market timing is about. By market timing I mean buying when conditions are in your favour and selling when they are against you. Even if you can imprecisely time the markets, in an inperfect manner, your returns will get boosted. I had earlier written a post on this blog showing how one particular market timing strategy achieves superior returns with less risk and lower volatility. (Link: http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html)

Market timing is THE essence of successful investing. Traders try to time the markets. Even long term value investors time the market, buying when stocks become cheap and selling when they get expensive. Momentum investors time the market and buy when momentum starts building up and sell when momentum starts fading or reversing.

So do not hide behind the cover of "I dont have time to trade" defense mechanism. You dont need to look at the market every day or every week. Learn how to time the markets, afterall it is your money.


Myth 3:
Making money is all about picking stocks.
Another big myth!
No doubt, stock picking is important. You want to be in a stock that goes up. But merely picking a winning stock is of little significance if you get the other things wrong. You will not make much money.
What are the other things?
Intelligent exits and proper volumes of purchase

Not much fun in picking up Unitech at 100 to see it go to 550 and then back to 130.
You need to sell sufficiently high to benefit from the big price move.
And you need to buy in good volumes on such stocks to make significant money. Your 'position sizing' needs to be correct. Buy too little and you wont make much money. Buy too much and you run the risk of large losses if losses come about.

Look at the portfolios of various mutual funds. 90% of the variance in their performance comes from position sizing, i.e.from their decision on how much to buy. Only 10% comes from superior stock picking.

You don't need to be a great or even a good stock picker to make a lot of money.
Being average is fine as long as you follow a few cardinal rules in investing:
-Trade with the trend. That is where large profits originate.
-Let your profits run but cut your losses short
-Manage risk. Buy enough to make you a bundle, but short of anything that could lose you a lot of money.


Continued.....