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.