Tuesday, June 28, 2016

You Only Find Out Who is Swimming Naked When The Tide Goes Out

What did Warren Buffett mean when he said, “You only find out who is swimming naked when the tide goes out?”

Clearly, he is talking about two things:  Quality of Stock, and Price Paid for Them.

When the share market is in the midst of a “Bull Run”, the market value of your portfolio will certainly cover-up all mistakes made in selecting the company and the price paid for acquiring the shares; every stock in the portfolio shows a blue tick, and a unrealized gain, prompting the lay investor to falsely believe he is a great investor, bestowed with abundant investment wisdom.

No wonder, the seasoned value investor’s portfolio too, is showing significant growth – may be on par with the benchmark index, like BSE Sensex, or surpassing it or underperforming it – nevertheless it’s value has certainly grown.  However, the “value investor”, trained unceasingly in keeping the emotions under strict control, is Stoic. 

In fact, you can observe a distinct deviation in her behavior, either she is very parsimonious in investing in stocks or has given the market a total miss; instead, preferring bonds or other fixed income securities.  On rare occasions you may observe that the value investor had sold shares of a company or two, at handsome profits of course, which had recently gone through some fundamental changes, which are not to the liking of the investor or which are contrary to value investing principles.

On the other hand, our lay and ignorant investor, who is under the false credence of superior investment acumen, is continuing to pour money into the stock portfolio.  Drunk with “Greed” and “Overconfidence”, he might be investing even borrowed money.

The markets are on a roll, in the meantime, lulling the investor community, the so-called “Experts”, media, regulators and political leaders into a false sense of everything-is-going-good feeling.

At last, the time for reckoning arrives!  Some catastrophic Global Event like Lehman Brothers triggers a market crash.  Portfolios world over start bleeding.  Margin Calls and unilateral squaring up of traders’ positions accentuate both the market fall as well as lay investor pain.  Euphoria, which was prevalent, not so long ago is replaced with gloom. 

The tide is going out fast, and you find out who is swimming naked -  who is safe and who getting washed away in the tide.






Monday, June 27, 2016

Risk Comes from Not Knowing What You are Doing

Businessman jumping across the mountain taking risk
Businessman jumping across the mountain taking risk

Driving an automobile is Not Risky; driving, without adequate training is – not only to the driver but also to all other unsuspecting road users, and that is why my Guru, Warren Buffett said, “Risk Comes from Not Knowing What You are Doing”.

Often I have heard people proclaim, sporting an, “I Know Everything” smile, that they diligently avoid investing in stocks, as it is Highly Risky.  On questioning how they had come to such a conclusion, they would invariably attribute the wisdom to their parents, teacher, colleague or friend. When questioned where they would prefer to invest, they would retort, with authority, “Corporate Fixed Deposits and Bonds – Rock Solid Safety”.  Sadly, after a few years, I have seen many of them Loose both Capital and Interest, and repent their poor investment decisions.

The moral of the story is, Risk or the Lack of It, does not lie in any particular instrument, but lack of knowledge.  A fixed deposit with a government bank in India indeed is as solid as rock, there is no doubt, but with an interest rate around 7% per annum and inflation near or above the rate of return, the “Value” of your investment is bound to be eroded for sure, over a period of 15 to 20 years.

On the other hand, if an investor had invested Rs.1,00,000 ($ 1470) in “NIFTY 50” in January 1995 and had simply forgotten about it, today in June 2016, it would have grown to Rs.809,400, a growth of 709% or a Compounded Annual Growth Rate (CAGR) of a whopping 32.99% per annum.  Even after an assumed, high, inflation rate of 10%, the investor would be left with a net return of 22.99%, Compounded Every Year!  So, Where Does Risk Lie? Not in the “Instrument”, certainly, but in “Ignorance”.