Investing 101: After Sensex’s 807-Pt Fall, You Should Keep a 10-Year Investment Horizon

If you are panicking at the 807-point fall in the Bombay Stock Exchange Sensex yesterday (11 February), know that it is human nature to be afraid when things are crashing all around you. But every market crash is an opportunity for the intrepid, but with two major caveats: Don’t try to guess where the market is headed, and don’t put money in the market that you cannot afford to kiss goodbye to.

If you respect these givens, now is as good a time as any to invest in stocks. You will find bargains that were not available over the last 12 months. So here are the investing basics to go by.

First, look at your asset allocation. Equity is risk investment, and bank FDs, post office instruments, etc, are fairly safe. If you have Rs 100 to invest and you cannot afford to lose any of it, all of it should be in safe places, even places that give relatively low returns. It is only the money you can afford to write off that you should invest in equity, including equity funds, even though the latter are a bit less risky than doing it yourself. You could also try index funds, which at least ensure that you won’t do worse than the index.

Second, equity is long-term money because the market can go up or down. I believe a 10-year horizon is safest though it is possible to make gains even in three-five years. A 10-year expectations cycle will enable you to ride out prolonged bear cycles. Given the shape the world is in, one should invest only with this kind of time horizon today. Any shorter cycle would be courting greater risk.

So, if you are planning a daughter’s wedding based on your market investments, forget it. Unless your daughter is just five or 10 years old.

If you are 30-40 years old and think investing in stocks would be good for your retirement corpus, sure, it’s worth doing.

But remember the 10-year horizon. Between 1999 and 2003, for example, the Sensex barely moved around 3,000. Bank FDs would have given you better returns. But from 2003, the index took off vertically, before peaking in 2008. If you had invested anytime between 1999 and 2003, you would not have made money for four years. The big explosion came in 2003 and beyond.

We may be in one of those long hibernation periods, so any short-term expectations would be wrong unless you are lucky.

Third, the experts will tell you don’t try to time the market, but this is only a half-truth. While it is 100 percent true that even experts can’t tell if a market has peaked or troughed, anyone can tell if we are in a bear phase or bull phase. If it is in a bear phase – like now – you could start investing, even though you may still end up with losses on a two- or three-year horizon. Simple rule: the time to start investing steadily is when the markets seem to be crashing all the time and are far away from their peaks – at least 15-20 percent below the last peak, in my opinion.

Fourth, the ones who will gain the most are those who try to learn by themselves. Just as you can’t learn to swim or ride a car just by reading a book or listening to an expert, you can become good at market investing only if you do it yourself. If you don’t want to take the trouble, you should anyway invest through mutual funds.

A bonus for individual investors: the market is always liquid for individual investors, and not so for big institutional investors. Meaning: when you buy small lots of, say, a mid-cap or small-cap stock, the market price will not balloon. But when a mutual fund tries to do that, its sheer volume of purchase raises the cost of purchase. So mutual funds will make less money on the stock that if you do it yourself. The downside is, if you are wrong, you will make a bigger loss all on your own.

Fifth, for novices, SIPs are best – systematic investment plans, where a small amount is invested every month. SIPs are the best thing to do in a bear market, as is apparently the case now, where prices could well crash further. With every crash, you get more shares/mutual fund units in your portfolio. Some online trading companies offer you the option of SIPs both in mutual funds and in specific shares. So try both, if you have the ability to take losses in the short run.

Sixth, don’t assume that debt and gilt funds are safer than equity or immune to losses. Only bank FDs and post office savings schemes protect your nominal capital, for they are effectively guaranteed by the government – especially the latter. Bond funds are vulnerable to interest rate risks, though right now if things are going crash, bang, thud, the chances are rates may well be eased, which means bond and debt funds can make capital gains as yields fall (if they fall, that is).

Seventh, never borrow to invest. Borrowings have costs while investment return in the short run can often be negative. So you lose on two counts – the interest cost you pay on borrowing, and the loss on equity values (or debt values).

Eighth, never be a trader. Trying to make money in short-term swings of the market is only for experts, and it needs tremendous discipline. You have to follow rigid rules, like taking a loss when stocks fall too soon. So, unless you are that specific person who lives by technical charts, forget this avenue.

Ninth, remember this reality: you get returns on stocks only because of an increase in liquidity; that is when money is easy or comes at a low cost, and people are willing to put on equity using the cheap money. This is why the Dow hit new peaks when the American economy was in trouble post-2008. The US Fed made money so cheap and plentiful, that a lot of it went into stocks. Right now, when Indian banks are in a difficult situation with so many bad loans, it is unlikely that they will expand lending or the Reserve Bank will flood the market with liquidity. Your returns depend on when liquidity returns.

Tenth, don’t forget luck. You can pick the best fundamental stock, or buy at the bottom of the bear market, but your returns also depend on luck. No one could have known in 1999 that the markets will be flat; no one could have known in 2003 that the markets are going to be taking off vertically. If you are lucky, make sure that you book your gains when you achieve your return targets. You may make less money if the market rises further, but at least, you won’t have to cry over losses. The worst regret in stocks is to feel bad because stock prices have gone higher after you sold at a profit. That is part of the game. Not a reason for regrets.

The markets tend to fall and rise quickly these days, thanks to institutional investors, who catch rising or falling trends early, and by deciding fast, they accelerate the inherent trend in indices or stocks. The implication is simple: if the markets have bottomed out, they will not take much time to rise to their old levels. So don’t be surprised if you do not have to wait 10 years to make a profit on stock investments.