Markets: This, too, will pass away!
Source: EM
As the Indian equity markets tread on a volatile path after the bull run that was witnessed till the beginning of May 2006, a quote perfectly symbolizes the thought process going in the minds of investors at present - 'This too will pass.' And in these volatile times, it seems wise to go back to some of the investment basics that have faced the test of times, yet remaining as true to the core as they were when thought out decades back. The famous investment guru, Benjamin Graham, once said, 'Investment is most intelligent when it is most businesslike.' Yet, if one were to take a look at the profile of an average investor in the equity markets, there emerges a very capable businessman who has gained success in his own business but has operated in the markets with complete disregard of all sound business principles of business. In this regard, let us take a look at some of these principles that have been completely violated in the markets, but if followed with discipline, would result into investors earning adequate returns. The first of these principles, as given by Graham, is to 'know what you are doing.' This is similar to knowing your business. In the investing sense, this means that an investor should not try to make business profits out of his investments. More simplistically, this means that he should not try to earn returns in excess of normal interest and dividend income, unless he knows as much about his investments' values as he would know about the value of his business. If he defies this basic principle, he is not an investor, but a speculator who is betting on his intuition without the adequate knowledge to back the same. The second principle is 'not letting anyone else run your business' (stock market investment, in this sense) unless one is pretty sure of the integrity and ability (the management of a company or a mutual fund). This rule would help investors determine the conditions under which he entrusts his money for someone else to manage. The third principle is for the investor to 'undertake an investment only when a reliable calculation indicates that there is a fair chance for a reasonable return on the investment.' More simply, based on this principle, an investor's strategy for earning profits should be based on careful calculations and research rather than plain optimism. Not following this principle is equivalent to putting your principal to a considerable risk. And finally, the most important principle is to 'have the courage of knowledge and experience.' This is to say that once you have arrived at a conclusion from the facts and careful calculations, you need to act on the same caring not much about what everyone else is doing (or betting on). This is discipline, the most important rule at the root of sound investing. By following these principles, you can ensure that the consequences of your mistakes would never be disastrous. And more importantly, you will not blame the stock markets for your losses. When that happens, no matter what the markets throw at you, you will always be able to say with much confidence, 'This, too, will pass away.'
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