How to become a better investor

How to Become a Better Investor

By

Subhankar Ghose
http://investmentsfordummieslikeme.blogspot.com

December 31, 2009
(I own the copyright of this eBook. Please do not copy or distribute without my permission.)

http://investmentsfordummieslikeme.blogspot.com

Table of Contents
Page 1. Introduction 2. Chapter 1 : How to lose money and become a better investor 3. Chapter 2 : How to lose less with a Stop-loss 4. Chapter 3 : What are your Future Options? 5. Chapter 4 : Don’t be a Bull or a Bear in the Stock Market 6. Chapter 5 : When the going gets tough, do nothing 7. Chapter 6 : Learn stock portfolio selection from a tall ex-cricketer 8. Chapter 7 : Why you shouldn’t Diversify 9. Chapter 8 : Market Cycles and Sectors 10. Chapter 9 : Which Sectors should you invest in? 11. Chapter 10: Learn from my investment mistakes 12. Chapter 11: “Time in” vs. “Timing” the Market 13. Chapter 12: How to Reallocate your Assets 14. Chapter 13: Learn about Contrarian investing from a great tennis player 15. Chapter 14: If you must SIP, sip good Darjeeling tea 16. Chapter 15: Start your own risk-free FMP 17. Chapter 16: BeES in your bonnet? 18. Chapter 17: Stay ahead by being interested in interest 19. Chapter 18: What the CRR-SLR-Repo rates mean for investors 20. Chapter 19: Why Michael Ballack is a role model for the better investor 3 4 6 8 9 10 11 13 14 15 17 19 21 23 24 26 27 29 30 32

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Introduction There were three reasons why I started to write an investment blog in June 2008. First, the stock market was in the throes of a severe bear market after 5 years of euphoria. I remembered the boom and bust during the Harshad Mehta scam in 1992 and how traumatic it was for me. I felt that sharing some of my experiences in the stock market could help young investors to learn and avoid the mistakes I had made. Second, while there are a plethora of web sites and blogs that offer stock tips, I failed to find a single web site or blog that educated investors by explaining the concepts behind fundamental or technical analysis in simple language, with examples from the Indian stock market. Third, the blogging platform offers instant reach to an audience, and allows quick two-way communication with readers - thanks to the proliferation of the Internet. That helps in regularly guiding, resolving doubts of, and learning from, investors. I had to struggle during my early investment days in the 1980s. There was no Internet and no SEBI regulations and no business TV channels and no quarterly reporting by companies. The only way to find out about companies was from brokers or friends. The only way to know what price a stock was trading at was to call your broker and accept whatever he said. Charting had to be done manually on a graph paper after prices were published in the next day’s newspapers. Things have changed quite a bit since then – mostly for the better. If there is a problem now, it is an overload of information and stock ideas! Investors are better informed and better educated. Still, investment psychology – particularly the extremes of greed and fear during bull and bear phases – remains pretty much the same. At every market peak, a new lot of investors keep jumping into the market without adequate homework, only to lose their hard-earned money. So, my effort at investor education through my blog continues. Many of my readers have been urging me to prepare an eBook using my blog posts, so that they can easily refer to some of the posts without wading through my entire blog. They have motivated me to produce this eBook, and I hope they would not mind if I don’t thank them individually. The effort took longer than I had expected, and for reasons of brevity, I have chosen a few posts from the period June 2008 to January 2009. Hope readers of this eBook will learn to become better investors by reading it.

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 1: How to lose money and become a better investor There are only two rules of investments (as per legendary investor Warren Buffet): Rule number 1: Do not lose money Rule number 2: Read rule number 1 Such great advice is totally inappropriate for those who are investing in the stock market or mutual funds for the first time. It is almost like saying "Do not fall down" when learning to ride a bicycle. Just like you will fall down a few times before you learn to ride a bicycle, you will lose some money before you learn how to invest in stocks and mutual funds. In fact, losing money is an essential part of learning to become a better investor, though this goes against the grain of logic. When you begin making your initial foray into investments, chances are you will not have too much cash in hand. So going to an investment advisor wouldn't make much sense. You will end up going to a relative or a friend - whom you consider to be an expert - and ask for tips or ideas. Despite the best intentions of all concerned, the first couple of investments will probably go sour. Even if the investments actually generate a profit on paper, you may not be able to take that profit home because you will not know when to sell! You may be among the unfortunate many who got caught up in the buzz of the Sensex hitting 20000, and jumped in to the market in January 2008 - when all the excitement and euphoria was at its peak. That means you are probably still sitting on substantial losses. Shortly afterwards, the market began to drop and you were left holding your investments at higher prices - not knowing what to do. When the market dropped some more, you got into a panic and called your friend or relative for advice. Chances are, the advice was: "Hold on a little longer; the market will rise again sell then." The market did rise but not to the level at which you entered. You may have held on, hoping to get back your ‘buy price’ and break even. That was just the time for you to turn your ‘paper’ losses into ‘cash’ losses. Which means actually selling the shares in which you were losing money instead of holding on to them. Why would you do such a 'foolish' thing? Because you never know how low the market can go, and when it will rise again.

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http://investmentsfordummieslikeme.blogspot.com If you buy a share at Rs 100, and it falls to Rs 50, you lose 50%. But if you hold on expecting to sell when the stock reaches 100 again, you are expecting a 100% rise in the stock price. Not impossible but highly unlikely. If the stock falls further to Rs 33, your loss is 67% but to get back your original Rs 100, the stock has to rise 200%! (Do not use such 'opportunity' to buy more. Your average price may go down, but your losses will keep increasing.) So you decide to 'book' your losses. Now what should you do with the money? Do not reinvest it back in the market right away. Put it in a short term fixed deposit or a Liquid Mutual Fund, and watch the Sensex move back up before reentering. A better investor will quickly learn the concept of a 'stop loss' - a price below which (s)he will 'book' losses and get out. Setting a stop loss is an art, and will depend on your risk taking ability and your conviction in the quality of the stock. A timid investor will run away from the market after such a money-losing experience and put the money in a bank - where inflation will eat away a major chunk. A smarter investor will decide to buy some books and interact with experienced investors to learn more about the subject. And he will already be on the road to become a better investor.

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http://investmentsfordummieslikeme.blogspot.com Chapter 2: How to lose less with a Stop-loss
"More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason" - Philip A. Fisher.

You should re-read the quote above. If you have been investing in the stock market for any length of time, you have surely succumbed to the 'coming out even' fallacy at least once. Truth is, ‘Mr. Market’ does not know at what price you bought a stock or fund. Nor does he care. But you do, and that is the root of the problem. I'm presuming that you performed due diligence in selecting a particular stock or a fund - carefully studying past performance, dividend records, peer comparisons. And yet, in spite of your best efforts, you pick a loser. It happens. All a part of the game. This is when your investing mettle will be tested. Will you swallow your pride and get out? Will you soldier on, 'knowing' that you've picked a winner that will surely make you rich soon? Or will you become a 'long term investor' simply because your short-term plans have got nixed? A neat little device, called a 'Stop-Loss' level, may save you the blushes. How does it work? Before you buy a stock or a fund, you should decide how much loss you will be able to tolerate. For an expensive stock, your loss tolerance may be less. For a cheaper fund it may be more. As a conservative, long-term investor, I like to set a stop-loss level of between 15% and 30% of the buy price. Let us say I'm planning to buy a stock for Rs. 100, and set the stop-loss at 20%. If the stock falls to Rs. 80 or below, I'll not wait and sell immediately - thus ‘stopping my loss’ at Rs. 20 per share. What if the stock price rises to Rs. 120? Do I have a huge grin on my face and brag about my stock-picking skills to all and sundry? I'll be lying if I said, 'No'. But what I also do is set a 'trailing stop-loss'. What's that? It means increasing the original stop-loss level by the same percentage as the rise in the stock's or fund's price. In our example, we will raise the stop-loss level to Rs. (120 - 24 =) 96. If the stock moves up to Rs.200 (this happens usually in bull markets - but also some times in sharp bear market rallies), the stop-loss level will now be Rs.160. Stop-loss levels not only help you to limit your losses, but a trailing stop-loss will protect your profits as well. Should the stock price suddenly fall to Rs.150, your

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http://investmentsfordummieslikeme.blogspot.com stop-loss level will be 'triggered' and you will sell off, still making a profit of Rs. 50 per share (that you bought originally at Rs. 100). The foregoing discussion has been written from the point-of-view of a conservative long-term investor. I have nothing against those who trade stocks on a daily basis, but I do not recommend trading to new or inexperienced investors. But if trading is what gets you excited, you may want to set 'tighter' stop-losses. In the recent bear market, the Sensex fell more than 60% from its January 2008 top of 21200. But many small investors were facing much bigger losses because of their penchant for buying smaller and ‘cheaper’ stocks and funds. The two lessons from such a traumatic experience are: (1) most stocks or funds that seem a bargain are not; better stick to proven performers and market leaders; (2) even if you've chosen the wrong stock or fund, applying a disciplined stoploss mechanism will limit the losses.

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http://investmentsfordummieslikeme.blogspot.com Chapter 3: What are your Future Options?

A British schoolboy cricketer had once approached Sir Geoff Boycott to learn how to play the hook shot. Boycott told him that the best way to play the hook shot was not to play it! "But how do I score runs?", the boy had asked. Boycott's response was typical: "Don't get out! The runs will come." Futures and Options (F&O) trading by small investors are akin to a young cricketer playing the hook shot. The chances of losing money overshadow the probability of scoring big. It is far better and safer to buy quality stocks and wait for your wealth to grow. Nowadays the lot sizes for F&O trading have been reduced, but the risks have not. Such trading is better left to professional and institutional investors who play for much bigger stakes and usually buy or sell in the cash market and hedge in the F&O market. There is no harm in being aware of what F&O trading is all about, and some smart investors can get clues about the market levels from the open interest volumes and the difference between spot and future prices. But I get confused when I hear talk about 'covered calls', 'strangles' and 'naked futures' and have stayed far away from F&O trading. Seems like I'm not in a minority of one. The legendary Peter Lynch has made the following comments in his book ‘One Up on Wall Street’: "I've never bought a future nor an option in my entire investing career.... Reports out of Chicago and New York, the twin capitals of futures and options, suggest that between 80 and 95% of the amateur players lose. Those odds are worse than the worst odds at the casino or at the race-track, and yet the fiction persists that these are 'sensible investment alternatives'.... I know that the large potential return is attractive to small investors who are dissatisfied with getting rich slow. Instead they opt for getting poor quick.... Warren Buffet thinks that stock futures and options ought to be outlawed, and I agree with him."

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Chapter 4: Don’t be a bull or bear in the Stock Market The triangular headed South African python is a truly awe-inspiring reptile massive in length and weight, immensely strong with an intricately patterned shining skin. The other day, on the National Geographic channel, the camera followed such a beauty as it slowly slithered through the bushes and weeds and glided into a watering hole. There it hid with only its snout above the water - and waited patiently. Day followed night and night followed day - and still it waited. Animals big and small, frisky and sloth, came to the watering hole for a drink. The python didn't move. Six days and nights passed - and no one except the camera-person knew that the python was lying in wait. On the seventh evening a herd of deer came for a drink. A younger member ventured a little further from the water's edge unaware of the peril. Suddenly, the water hole exploded into action. With its immense muscle power, the python lunged out like greased lightning and in the blink of an eye had wrapped itself around its prey. The poor animal probably didn't even know what hit him. The South African python is used to spending weeks and even months without feeding. Some times it eats the odd rodent or bird. But when it really wants to eat, it plans its every move and with infinite patience grabs a large meal so that it won't have to eat for a long time. Like the python, a successful long-term investor does not need to 'feed' (i.e. trade) every day or every month. Once in a long while, the stock market provides an ideal opportunity to grab a few frontline stocks at mouth-watering prices. Back during the 2002-2003 bear market period, stocks like Tata Steel was available at 100, M&M at 90, ITC at 60 (actually 600 for a Rs 10 share). All three subsequently offered bonus shares at 1:2, 1:1 and 1:2 ratios respectively. There were many other shares going for a song and which made a ton of money for savvy long-term investors. Since then, we had a one-way bull-market with Vshaped corrections in 2004 and 2006. But after 5 long years we had a fullfledged bear market, which ended in March 2009. For long-term investors, the period from January 2008 – March 2009 was the right time to behave like the python. Not to jump in, but to conserve their muscle power (i.e. cash), decide on a few target companies and wait patiently for the market to start rising.

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 5: When the going gets tough, do nothing Edward Kennedy 'Duke' Ellington was a well-known jazz pianist who later became a famous composer and bandleader. Considered by many to be one of the foremost influences in jazz music, his complex compositions and arrangements brought jazz to the mainstream of American music. Several of his compositions have become jazz 'standards' - recorded and performed by a whole host of singers and musicians through the years. Some, like 'Caravan', became so popular that even pop instrumentalists performed and recorded the song. One of Duke's compositions - 'Do nothing till you hear from me' - has relevance to the current state of the Indian stock market, if you replace 'me' with 'Mr Market'! With the market hitting new highs every day, many small investors are utterly perplexed about what to do. Some feel this is a great time to buy. Others had seen their portfolios erode away in the bear market and are waiting for the next big correction to enter again. The more adventurous ones are writing puts and calls and probably making their brokers rich! Risk-averse investors are looking at bank fixed deposits and company deposits. But the really smart ones are riding out the market turmoil by doing nothing. An avid mountain climber once commented about his frequent attempts at climbing the Everest: “I try to climb the Everest because it is there!” Well, the stock market is very much there - and will be there for quite some time longer! Does that mean that you should always be buying and selling? Remember, 'do nothing' does not mean 'remain completely inactive'. This is a great time to do fundamental analysis of companies. Find out which ones are offering greater value in terms of dividend yields, price to book value ratios, operating cash flows, profit margins. Make a short list of such companies and track them on a daily basis. Then wait to hear from ‘Mr Market’. He will start giving you diverse and interesting clues - such as, changes in interest rates, a decrease in the advance-to-decline ratio, an aversion to discussion about the stock market among your market-savvy friends. The cumulative effect of such clues will indicate that the correction may be around the corner. Till you hear from me (I mean, ‘Mr Market’), take your spouse out for a candlelit dinner, take that dream holiday to Mauritius or Machu Picchu but do nothing about buying or selling in the stock market. If you absolutely must buy or sell, at least wait for the quarterly results before doing so.

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 6: Learn stock portfolio selection from a tall ex-cricketer During his playing days, former England & Sussex skipper Tony Greig literally towered over his opposition. His medium pace and offspin bowling and aggressive batting earned him the 'best England all-rounder' title till Ian Botham took over his mantle. But he is best known for his controversial comments - used to intimidate and provoke the opposition. Some may remember his "I'll make them grovel" statement about the West Indies team that really stirred up a hornet's nest. The comment I remember best is about which players to choose if he was the captain of a World XI. In typical controversial Greig-like fashion he said that he would prefer to have a Geoff Boycott in his team instead of a Gary Sobers. Now anyone who knows anything about cricket knows that Gary Sobers is the greatest all-rounder in the history of the game. Boycott is best known for his long, strokeless stints at the crease that frustrated opposition bowlers. Greig's logic was simple - Sobers could, and often did, win a match singlehanded with his flashy stroke play. But he was equally likely to score a zero. Boycott however could be relied upon to grind out scores of 30s and 40s in game after game. That brings us to the biggest lesson in stock selection. Stock market success is all about staying power over the long haul. So you need stocks in your portfolio that have performed well - but may not be spectacularly - year after year after year, through bull and bear markets. In terms of capital appreciation (often through attractive rights and bonus offers) and also by providing regular income through steady or increasing dividends. The Boycotts of the stock market are Hindustan UniLever, ITC, Colgate, Reliance, Tata Steel, Tata Motors, Mahindra and Mahindra, BHEL (you get the gist - this list is not meant to be exhaustive). The Rico Autos, Prajay Engineers, Suzlons, Gujarat NRE Cokes shine for a year or two and then fade away. Does it mean that your portfolio should only contain 'boring' stalwarts? Not really. But the high-fliers of the day should form only a small part. A formula that works for me is 8 to 10 stalwarts that form 90% of my 'core' stock portfolio. (And the best time to build such a 'core' portfolio is when the stock market is in a bear grip.) The balance 10% of my portfolio is made up of 6 to 8 mid-caps and small-caps with a potential to hit the big time. I'm mentally prepared to lose all the money allocated to this 10% 'speculative' part of my portfolio. You have to choose the percentage allocation that suits your risk profile. But a word of advice - don't let

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http://investmentsfordummieslikeme.blogspot.com the 'speculative' part exceed 25% of your portfolio. If it does - and that is likely to happen near a market top - reallocate by booking partial profits. If you prefer to invest in mutual funds - and most investors should, unless they have the time and interest to pursue the solid amount of research required to maintain a good stock portfolio - then the Boycott's are HDFC Equity, DSPBR Equity, Magnum Contra, HDFC Prudence, Magnum Tax Gain (once again this list is not meant to be exhaustive). The 'speculative' portfolio can contain the ICICI Pru Infrastructures, Reliance Visions, DSPBR TIGERs.

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http://investmentsfordummieslikeme.blogspot.com Chapter 7: Why you shouldn’t diversify Investment analysts and the pink papers cry themselves hoarse about why investors must diversify their portfolios to mitigate risk and enhance returns. This is another one of those investment myths that need debunking. Peter Lynch coined the term di'worse'ify about companies who enter unrelated areas of activities. The term applies equally well for investors. 50 stocks or 20 funds in the portfolio is a classic case of di'worse'ification. Individual investors should try not to have more than 10 stocks or 5 funds in their portfolio. Otherwise it takes too much time and energy to keep track of the performance of individual shares and funds. The richest individuals in the world tend to have extremely concentrated portfolios. Think about Microsoft's Bill Gates, Oracle's Larry Ellison, Walmart's Sam Walton, Infosys' Narayanmurthy. While the average investor like you or me can't be compared with the legends mentioned, we can reduce risk and enhance wealth by placing a few concentrated bets on outstanding stocks. The key word here is 'outstanding'. If you prefer particular sectors, avoid sugar or cement or real estate that give you windfall profits one day and huge losses on another. Concentrate on defensive sectors like FMCG and Pharmaceuticals. You'll get steady and regular returns through price appreciation and dividends. And the downside will be limited. So here is a formula for investment success. Buy a few outstanding stocks from the FMCG and Pharma packs - like Colgate, HUL, ITC, Nestle, Glaxo, Lupin, Sun Pharma. These will provide steady returns and limit your losses during bear markets. Balance such a sector tilt with stalwarts like Reliance, L&T, Tata Steel, M&M. For a little extra, albeit risky, returns add the odd Yes Bank and Opto Circuits. Mutual Fund investors can buy a couple of diversified equity funds (like DSPBR Top 100, Sundaram Select Focus), a couple of Balanced Funds (like HDFC Prudence, DSPBR Balanced) and an ELSS fund (like Magnum Tax Gain or Sundaram Tax Saver). If you feel that such a portfolio is boring or uninteresting, then that is a good indication that you will make very good returns! For excitement and adrenaline flow, you can always visit Las Vegas or the Mahalaxmi race course!

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 8: Market Cycles and Sectors The stock market rises and falls in a cyclical fashion that often 'leads' the economic cycle by several months. The signs of an economic down turn were quite visible in December 2008, but the stock market had started to 'discount' that fact much earlier in January 2008. The steep drop in the Sensex from 21200 in January 2008 to 7700 in October 2008 must have been traumatic for many investors for whom this was the first experience of a bear market. The sideways consolidation for the next four months must have been quite frustrating for those who were struggling to understand what they should be looking for next. The sudden about turn in March 2009 followed by a one-way bull rally for the next 10 months must have been equally perplexing. When all the fundamental and technical analysis still leaves common investors bewildered, a look at how different industry sectors have performed during previous bull and bear market cycles may be enlightening. The first signs of a stock market revival become visible when stocks from the financial sector like banks and NBFCs (Non-banking financial companies), retail and transportation sectors start to rise and consumer durables like home appliances, cars and trucks start showing improved sales. The economic story is nothing but bad news. As the bull market begins to mature, and the economic cycle starts to improve, the sectors to watch will be technology, capital goods (like construction machinery) and construction materials (like cement and steel). These will usually be followed by chemicals, paper, non-ferrous metals, petroleum - when the economy starts to gather momentum. Near the peak of the bull market, the real estate and energy sectors tend to dominate. The FMCG and Healthcare sectors come to the forefront as the stock market begins its bear phase. The economic cycle tends to be at or near its peak around this stage. As the bear market matures, utilities and services sectors try to hold the fort. The economy is now well and truly in its downward cycle. As the poet T. S. Eliot wrote in "Little Gidding": What we call the beginning is often the end And to make an end is to make a beginning. The end is where we start from.

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http://investmentsfordummieslikeme.blogspot.com Chapter 9: Which sectors should you invest in? In the previous chapter, the sectors that receive prominence during different stages of the economic and stock market cycles were discussed. Does that mean that you, as a small investor, should look at investing in all those sectors? Probably not. Fund managers, who are under pressure to perform in the short term, have no alternative but to move in and out of sectors depending on the particular stage of the stock market cycle. They also have access to company managements and better research resources and larger funds than small investors. With considerably less funds and little or no research capabilities, small investors like you and me are better off choosing only a handful of sectors to invest in. Some industries are in an environment that helps to create substantial competitive advantage. It is easier for the companies in such industries to make money. Four sectors that I like - based on their competitive advantage and cash generation capabilities - are: 1. FMCG: Strong brands built up over the years create huge competitive advantage. Companies tend to be solidly profitable, debt free and generate a ton of cash (which is distributed to investors through generous dividends). The market leaders have been around for many years, so they are slow but steady performers. This sector is practically recession proof and should form a significant part of a small investor's core portfolio. The FMCG sector is often called a ‘defensive sector’ because FMCG stocks tend to fall less during bear markets. Companies to look at are HUL, ITC, Colgate, Nestle, Dabur, Marico. 2. Pharmaceuticals: Like FMCG, Pharma companies are recession proof, have strong brands, are hugely profitable and good dividend payers, and long term growth is assured because of the large population. Multinational Pharma companies have access to better product pipelines from their overseas parents. Domestic Pharma companies profit from generics and contract research and manufacturing. This is also a ‘defensive sector’, and should receive pride of place in your portfolio. Companies to look at are Glaxo Pharma, Aventis, Sun Pharma, Lupin, Cadila. 3. Financial Services: Banks pay less interest to depositors and lend the money at higher interests to borrowers. For current account holders, banks pay nothing at all. Many banks generate additional income by selling other financial

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http://investmentsfordummieslikeme.blogspot.com products to their customer base - such as insurance, demat accounts, credit cards, mutual funds, home loans. Home loan companies tend to be highly profitable with long-term growth assured. Companies to look at are State Bank of India, HDFC Bank, Axis Bank, HDFC, LIC Housing Finance, Sundaram Finance. 4. Media: Many companies have competitive advantage through regional language and regional market domination. This sector also tends to be recession proof, because people will read newspapers and watch TV whether there is an economic downturn or not. Companies one can consider are Jagran Prakashan, HT Media, UTV. Why am I suggesting sectors that are recession-proof and ‘defensive’? Go back to Chapter 1 and re-read the two ‘Rules of Investments’. Always remember those two rules. Most investors buy stocks or funds without doing adequate homework, and end up buying losers. Buying into defensive sectors will not give you spectacular gains. Neither will it give you wealth-destroying losses. In the year ending March 2009, a year of economic downturn, most FMCG companies maintained or increased their dividend payouts. Are these the only sectors that an investor should look at? Obviously not. But this should be a good starting point for building a long-term portfolio.

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http://investmentsfordummieslikeme.blogspot.com Chapter 10: Learn from my investment mistakes When I look back on my track record of stock market investments over the past 25 years, I am amazed by the sheer number of downright idiotic mistakes that I have made. Without trying to sound immodest, I consider myself of above-average intelligence. Most of my friends, and I dare say a few enemies, will probably corroborate that. So how did I end up making so many mistakes in stock investing? And was I in a minority of one? Turns out that most amateur investors, and several professional ones including acknowledged experts, have made their share of similar mistakes. Why do apparently intelligent and experienced people make ridiculous and stupid investing mistakes? The answer may lie in an area of study called 'behavioral finance', which studies the effect of human psychology on financial decision making. Have you ever bought a share only to see its price going downwards? Or, decided not to buy a share (or bought only a small quantity) at a particular price, only to see the stock zoom up? This happens because the market has no idea nor is it bothered - about your ‘buy price’. The market moves as per its own logic. But we tend to 'anchor' at a particular price. If we buy at a higher price and the stock falls, our 'loss aversion' prevents us from selling it. Keeping a loss making stock in the portfolio does not seem like a real loss, whereas selling it would incur an actual cash loss. The way out is to have the discipline to stick to a 'stop-loss' figure (it could be 5 or 10 or 25% below the ‘buy price’ - depending on the stock's volatility and your risk tolerance), and sell as soon as the stop-loss figure is hit. What if the stock you buy starts zooming up, up and away (which usually happens in a bull market, but can also happen during sharp bear market rallies)? The smart investor's way is to keep moving the 'stop-loss' figure upwards by the same percentage as the stock's price and ride the rally. During the next market dip, sell when the now much higher stop-loss figure is touched. One of the biggest mistakes of all is to 'water the weeds and cut off the flowers'. This means selling off the good performing stocks too soon, and hanging on to the loss making stocks for long periods in the hope of a recovery. This mistake is often compounded by another big mistake. That is, overconfidence in your stock picking skills. During bull markets, any stock that you buy seems to fly upwards and you start feeling that you are a genius at stock

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http://investmentsfordummieslikeme.blogspot.com picking. When the market tanks, some of the high fliers - specially small and mid caps - lose as much as 80-90% of their peak value. It is no wonder that Benjamin Graham in his book 'The Intelligent Investor' has written: ‘The investor's chief problem - and even his worst enemy - is likely to be himself.’ (Haven't read Graham's book yet? Buy it tomorrow and then carefully read it, and then re-read it again and again.)

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http://investmentsfordummieslikeme.blogspot.com Chapter 11: “Time in” vs. “Timing” the market This is one of those investment debates that have been waged through the years, with no sign of a resolution in sight. With strong opinions on either side, it is quite likely that the controversy will endure for a long time. The dilemma arises because of the way most experts and analysts define 'timing'. They mean selling out your equity portfolio completely at market tops, and buying the same portfolio back at market bottoms. Common sense - which is not so common among the majority of investors dictates that such a plan is doomed to failure. Why? Because consistently deciding when a market has reached a top or bottom over several economic and stock market cycles is pretty nigh impossible. The stock market moves on its own logic, reflecting the collective sentiments of various market participants who have differing agenda. The hedge funds are in it for the short term (i.e. less than one year). Some of the Foreign Institutional Investors (FIIs) may invest for a longer term of 3-5 years. Pension funds tend to be real long-term investors who stay in for 10 years or more. As an individual investor it will be quite futile to try and outguess what these big boys are up to at any point of time. Chances are that they are better informed and have more research and financial resources than you. Therefore they can enter and leave the market in droves - driving up or smashing down prices before you can say 'Jack Robinson'. Research has proven that those who stay invested for the long term perform much better than those who try to exit and enter the stock market frequently. No wonder most fund managers say that 'time in the market' is preferable to 'timing the market'. While I cannot disagree with such strong logic backed by academic research, my investment experience has been otherwise. It arises from a different interpretation of the definition of market timing. For long-term investment success it is imperative that you try and time the entry into, and exit from, individual stocks. But do not try to exit from your entire portfolio or try to buy the whole portfolio back. In Chapter 8: Market Cycles and Sectors, I had explained that different sectors and therefore, stocks from those sectors, get prominence depending on the state of the economic and stock market cycles. When the Sensex was trying to find a bottom, FMCG stocks were hitting their 52 week highs whereas metal stocks were hitting their 52 week lows. So that was a

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http://investmentsfordummieslikeme.blogspot.com good time to exit from FMCG stocks and enter metal stocks. (You don't have to sell your entire holding in a sector. Partial ‘profit booking’ works pretty well.) Now, experts and fund managers will tell you that FMCG is a good defensive sector to enter in a bear market and metals will face a lot of pain over the next couple of years. They will be quite correct from the short-term view of the market. But a small investor with a long-term outlook has to play ‘contrarian’. That is the only way to 'beat' the market. While the 'time in' vs. 'timing' debate rages, my solution to the controversy is to replace the 'vs.' with 'and'; i.e. stay invested for the long term but time the entry into and exit from individual stocks.

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http://investmentsfordummieslikeme.blogspot.com Chapter 12: How to reallocate your Assets An investor friend had asked me a million dollar question during the previous bear market: The stock market has collapsed and blue chips are available at attractive valuations, but where is the cash to buy them? Many investors had been taken completely by surprise by the severity of the market decline. Let alone think about buying, many were scrambling to save whatever little was left of their portfolio. The attractive bank fixed deposit (FD) rates had prompted some to sell even at a loss and move to fixed income. Before we can start a discussion about asset reallocation, we need to be aware about asset allocation. Let us say that you are 35 years old and an investor in the stock market. The thumb rule for percentage allocation to equity suggested by market experts is (100 - your age). In this case, it will be (100 - 35 =) 65%. Now you may not feel comfortable with the associated risk of such an allocation to equity. No one is pointing a gun at your head. Choose whatever percentage makes sense to you. 40-50% if you are a conservative investor. 75% if you are aggressive about making high returns with high risk. The younger you are the more should be your equity allocation. Why? Because equities tend to earn the best returns over the long term, and when you start young, you have fewer responsibilities and hence can afford to take more risk. The older and closer to retirement you are, the more should be your allocation to fixed income. Why? Because the stock market can be in doldrums just when you are about to retire - when your regular income source will dry up. The (100 - age) formula comes in handy after all. For argument's sake, if you agree with the 65% equity allocation (this could mean shares, or equity Mutual Funds, or a combination), the balance 35% should be in fixed income, gold ETF (Exchange Traded Fund) and cash. A rough breakup can be 25% in bank Fixed Deposit (FD), or Post Office Monthly Income Scheme (MIS), or Public Provident Fund (PPF), or a combination of the three schemes, 5% in gold ETF and 5% in cash. The gold ETF is a hedge against inflation, but low returns may not permit a higher allocation. The cash is necessary for unforeseen opportunities - like a rights issue, or additional purchase due to a bonus issue or divestment. If you have Rs 20 lakhs as an investible surplus, this asset allocation formula means Rs 13 lakhs in equity/Mutual Funds, Rs 5 lakhs in fixed income, and Rs 1 lakh each in gold ETF and cash.

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Investment guru Benjamin Graham had advocated that on no account should you let your equity allocation go beyond 75% or go below 25%. If you follow this advice to the letter and spirit, it will enable you to reallocate your assets almost without thinking. How? Say the stock market enters a bull phase and the value of your equity portfolio becomes Rs 18 lakhs. Your total investment value now becomes Rs 25 lakhs (=18+5+1+1), and your equity percentage becomes 72% (=18/25). This is still below Graham's limit of 75% but is 7% above your original plan of 65%. Prudence requires that you start booking profits partially. If you are aggressive, you can ride the bull market till your equity value goes up to Rs 21 lakhs, while the other asset allocations remain as before. Now your equity allocation hits the 75% level (=21/28). No further waiting - start selling and invest the proceeds into fixed income and cash, to return to your original percentage allocation plan. What happens in the process is that you increase your wealth in real terms - not only on paper, because now your fixed income/cash amounts have increased. The actual re-allocation of the Rs 28 lakhs (=21+5+1+1) becomes Rs18 lakhs in equity, Rs 7 lakhs in fixed income and Rs 1.5 lakhs each in gold ETF and cash. Thanks to a bear phase, let us assume your equity value drops to Rs 10 lakhs from Rs 18 lakhs. Your total investment value is now back to the original Rs 20 lakhs (=10+7+1.5+1.5) but your equity allocation is now down to 50% (=10/20). Guess what? You now have some extra cash to deploy back into the market. And if you opt for Post Office MIS and/or quarterly interest from your bank FD in your fixed income allocation - then you will have even more cash and may not need to ‘break’ your FDs or gold ETFs to reallocate to equity. No wonder Warren Buffett has said that knowledge of simple arithmetic is enough to be a smart investor! (In real life, the arithmetic may become a little more complicated - but an Excel spreadsheet should take care of that.)

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 13: Learn about contrarian investing from a great tennis player While watching the epic Wimbledon final between Nadal and Federer on TV in June 2008, I was disenchanted by the number of viewer polls popping up on the screen about “The King of Wimbledon” and “The Greatest tennis player”. None of these polls mentioned the name of arguably the best player ever – Rod Laver. Sampras, McEnroe, Federer haven’t won at Roland Garros. Borg never won the US Open. Lendl and Rosewall never won Wimbledon. A handful of players have won all four majors in their career. Only two have won grand slams – all four majors in the same year – Budge and Laver. Only Laver has won the Grand Slam twice – once in 1962 in the amateur era and once in 1969 in the Open era. The defence rests. So what does Laver have to do with investments? In his book, “The Education of a Tennis Player” Laver writes about his attitude at Wimbledon – a tournament frequently interrupted by rain and blustery winds. He used to put on his whitest and starched pair of shorts and shirt, was well groomed and used to jump up and down with enthusiasm – as if the cold and rain was just the kind of weather he enjoyed. Far from it. It was specifically meant to demoralize the opponent, who was already feeling miserable in the inclement weather! Contrarian investing is not about selling at the market top and buying at the bottom, nor is it about buying realty stocks when every one is dumping them. It is about developing a mindset that prevents you from getting swayed by what is happening in the market on a daily basis. It is about ignoring all the buy calls given by so-called experts for ‘momentum’ stocks. It is about understanding which sectors and stocks have had their day in the sun, and avoiding them. Most important of all, contrarian investing is about making an investment plan based on your knowledge and risk tolerance, and having the self-discipline to stay with the plan through the ups and downs of the market. But all this is common sense, isn’t it? You will be amazed how uncommon it is amongst the majority of investors!

© Subhankar Ghose, 2009

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http://investmentsfordummieslikeme.blogspot.com Chapter 14: If you must SIP, sip good Darjeeling tea Edward Luce, the Financial Times correspondent who was stationed in Delhi for some time and is now based at Washington DC, has written an eminently readable book on the challenges affecting the growth story of modern India. Called "In Spite of the Gods", the book postulates that the reason for the success of a vibrant democracy is India's diversity. This diversity can be exemplified by how tea is prepared in different parts of India. In the west, tea leaves, water, sugar and milk are brought to a boil in a pan. In the north, spices like cardamom or ginger or both are mixed with the tea to make 'masala chai'. In the south, coffee is the preferred drink, though a large quantity of tea is grown in the Nilgiris. In the east, there is Assam tea - a strong rich brew prepared with milk and sugar. And then there is the queen of teas - Darjeeling - whose beautiful bouquet and light taste emerges only if it is brewed in a pre-warmed porcelain tea pot and sipped without adding milk. That brings us to another SIP, or a Systematic Investment Plan (another of those investment myths!). A disciplined and conscientious investor should have no problems with saving a fixed amount of money every month or every quarter. But is it necessary to invest that sum every month or every quarter on a particular date? The fund managers of most Mutual Funds will respond with a resounding "Yes". They even provide examples on offer documents or on business channels to prove their point that investing a fixed amount on a particular day every month or every quarter is the way to untold riches. Like a dummy, I listened to their collective advice and started a 12 months SIP in a well known diversified equity fund in the middle of 2004. By the time my 12 monthly installments were complete, I found to my horror that my average price per unit had continuously climbed up - along with the stock market. For my last monthly installment, units cost as much as 40% more than the units bought with the first monthly installment! One lives and learns. The only one who get rich from your SIP is the fund manager. SIPs provide steady monthly (or quarterly) revenue to the fund without the fund manager spending any time or effort in selling the fund. In a trending market - whether it is moving up or down - a SIP will always make your average cost per unit much higher than the cost you will incur at the beginning of an up trend or the end of a down trend. Is a SIP completely worthless? No, it works if a market is moving sideways some times up and some times down within a range - without a clearly

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http://investmentsfordummieslikeme.blogspot.com discernible up trend or down trend. How often do such sideways movements happen? Not very often, and even when they do, they last for a short period of 3 weeks to 3 months - not long enough to benefit from the price averaging that a SIP will provide. So heed a word of advice. Buy some good Darjeeling tea and learn how to prepare a proper brew. Savour the taste and flavour by taking small sips. And avoid SIPs. (Note: No, I haven't joined a tea company. But I have alluded to an investment myth: ‘Timing the market’ vs. ‘Time in’ the market. That myth was debunked in Chapter 11.)

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http://investmentsfordummieslikeme.blogspot.com Chapter 15: Start your own risk-free FMP The stock market spent 14 months (from Jan ’08 to Mar ’09) in a bear market. For investors who had entered the markets in the last 5 years, this was the first experience of how a bear market can destroy wealth. What we saw in 2004 and 2006 were just bear phases in a bull market, which provided opportunities to buy. Many small investors jumped in to buy in March and July ‘08 - only to see that there was no real recovery in the markets. Investors who had been in denial for the first few months of the bear market, started thinking and talking about how to protect capital and reduce losses. The mutual fund industry had been promoting Fixed Maturity Plans (FMPs) of 12 months+ duration and tried to explain the benefits of lower tax against a bank fixed deposit. Some fund houses even started offering 1 month FMPs - and were not mentioning anything about tax benefits! A small investor trying to protect his capital should start his own FMP and make it completely risk free. How? It is so simple, that it is almost a no-brainer. Let us say you have some investible cash of Rs 2 lakhs. What are your options? a) You can buy shares at low prices and watch them go lower; b) You can buy MF units and watch their NAV drop c) You can park it in a bank FD for 2 years and earn 10% interest d) Start your own FMP. Start by opening a FD account, but take monthly or quarterly simple interest. Depending on your risk tolerance set up a recurring deposit (RD) account with 20% or 50% of your monthly/quarterly interest. The balance interest should stay parked in your savings account for periodic purchases of shares and/or MF units. After 2 years, when your FD matures your entire capital will be intact, the RD account would be intact as well, and the shares or MF units that you purchase should start showing some real gains, as the bear market should change its trend by then. Simple, isn't it? But exciting? No. But who said building wealth is exciting? It is a slow and steady and disciplined process to be carried through for many years. (I try to preach what I practice. In Oct '07, I had sold a percentage of my holdings in shares and Mutual Fund units when the market looked overbought. With the proceeds, I opened a 3 years Fixed Deposit with a leading private bank. 20% of the quarterly interest earned was reinvested in a Recurring Deposit. The balance interest accumulated in a savings account. I gradually reinvested in shares and Mutual Fund units.)

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Chapter 16: BeES in your bonnet? After a steep fall and a short and sharp rally, the Sensex moved in a sideways consolidation phase for more than four months (end-Oct ’08 to early Mar ’09). At such times, it becomes difficult for fundamental or technical analysis to provide clear indications of what is to follow next. Reduction in the ‘repo’ and ‘reverse repo’ rates (read more about them in Chapter 18) had been 'discounted' by the market already. The overhang of tensions following the Mumbai terror attack in November ‘08 had put a spanner in the works of any quick recovery in the economy. Sideways consolidation phases are notorious for doing exactly the opposite of what every one expects them to do. During such consolidation phases, small investors have four choices. For the adventurous who rely on their stock picking skills, such phases may be as good a time as any to start buying into frontline stocks at beaten down prices and build a good long term portfolio. The less adventurous can select highly rated large cap diversified equity funds with good performance records over bull and bear cycles. For conservative investors the above two choices may still seem risky because of the possibility of further downsides. Also, when the market does turn upwards (as it eventually does), there is no guarantee that the shares or funds selected will perform well. Risk-averse investors should limit their choices to bank fixed deposits (FD) or index funds. FDs protect capital but are not tax efficient. At current interest rate of around 8%, the post-tax return at the highest tax bracket of 30% will provide a net return of 5.5% (which is lower than the real inflation rate). Index mutual funds allow the investor to buy into a particular index - it could be the Sensex or Nifty (or a Sector index). The underlying assets are the 30 Sensex or 50 Nifty stocks. There is no dependance on a particular fund manager's skills or whims in stock selection. The returns will be almost the same as the Sensex or Nifty performance. A good spin on an index fund is Benchmark Mutual Fund's Nifty BeES ETF (Exchange Traded Fund). An ETF is listed on a stock exchange and can be bought and sold at any time during the trading day through a broker by paying the Security Transactions Tax (STT). So for all intents and purposes, it is treated

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http://investmentsfordummieslikeme.blogspot.com like a share. There are no separate entry or exit loads. But brokerage costs apply. While the underlying asset of a share is a single company, Nifty BeES' underlying asset is the entire Nifty 50 stock group. Which means that by buying a unit of Nifty BeES, whose NAV is about 1/10th of the current Nifty level, you are effectively buying all 50 stocks that comprise the Nifty. Why not just buy an index mutual fund? The major advantage of an ETF like Nifty BeES is being able to buy or sell at any time during the day at the prevailing rate - whereas a mutual fund can only be bought or sold at the day's closing NAV (Net asset value). During volatile trading days, this can be a real advantage. The other unseen advantage, apart from there being no entry or exit loads, is that the fees charged by the fund is much less because an expert fund manager's stock picking skills are not required. So the disposable profits are higher. If you are a risk-averse investor with some spare cash, periodic investments in Nifty BeES can provide reasonable, if not spectacular, returns over the long term.

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http://investmentsfordummieslikeme.blogspot.com Chapter 17: Stay ahead by being interested in interest Interest rates are a 'leading' indicator. That means interest rates usually change direction before the stock market does. Some times this can happen several months ahead of time and some times it happens shortly before. Back in 2002-03 (if you can remember that far back!) when the stock market was in the doldrums, the returns from debt mutual funds were so good - upwards of 15% - that a certain foreign bank's mutual funds division didn't even bother to include an equity fund in their portfolio! Then interest rates started falling and the stock market had started picking up. By the time they woke up to the fact and came out with some equity funds, they were way behind in performance. Eventually, the bank's mutual funds division had to be sold off. The situation had drastically changed by 2007 when interest rates started moving up again. Conservative Indian investors started moving money back into bank fixed deposits. Inflation hadn't reared its ugly head. However, that was the first warning sign that the stock markets were going to be in trouble. Why? Because most 'punters' (the gamblers who play with options and derivatives) bet with borrowed money - many a times loaned by their brokers. As interest rates move up, their cost of doing business goes up and makes the margin of profit minimal. The higher interest rates also have a cascading effect on the economy particularly in rate-sensitive sectors like banks, automobiles, real estate. The cost of doing business goes up for all of them. Less people take out loans at higher interest rates, so they hold back on their vehicle and apartment purchases. To top it all, the huge run up in oil prices pushed inflation up - causing the Reserve Bank to raise interest rates even further to curb inflation! Then the FIIs started to depart. Talk about a 'perfect storm'! How does the nightmare end? A necessary - but not necessarily sufficient condition is when interest rates start moving down again. That is the first sign that the market can turn back up. Inflation is not always bad for stocks. Some sectors may have pricing power, either due to temporary supply-demand mismatches or due to the price elasticity of the product (medicines, liquor and cigarettes come to mind). Rising cost of inputs is offset by raising prices of the end product. More cash flows into the coffers leading to higher profits and EPS. That in turn means higher stock prices.

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http://investmentsfordummieslikeme.blogspot.com Chapter 18: What the CRR-SLR-Repo rates mean for investors It is important for investors to try and understand the basics of economics and monetary matters. A lot of investors may be wondering how all these different rates can affect them. So here is a 'dummies guide' to how the RBI controls the supply of money in the economy to stimulate growth or reduce inflationary pressures. The Repo rate is the rate of interest charged by the Reserve Bank of India (RBI) to commercial banks who may need to borrow some short-term funds against securities. (The Reverse Repo rate is the rate of interest paid by the RBI to the banks who may park short-term funds with it. Usually the RBI pays a lower rate of interest than it charges the banks for short-term funds.) The Cash Reserve Ratio (CRR) is a percentage of the total deposits with commercial banks that they need to keep with the RBI. The Statutory Liquidity Ratio (SLR) is a percentage of deposits that commercial banks need to invest in government securities. What purpose is served by such means? It is for the safety and security of the funds available in the banking system (which in turn helps investors like you and me). It is also for controlling the supply of money (or liquidity) in the country's financial system. The Foreign Institutional Investors (FIIs) were lured by the growth prospects of the Indian economy and brought in huge funds (by Indian standards) to purchase shares of Indian companies. Indians working overseas also channeled money back to the country for investments because of the comparatively higher interest rates. As demand for products and services kept rising, capacities got stretched, and prices were hiked. Industries went in for capacity expansion availing cheaper overseas funds. With higher production the GDP kept rising, attracting more foreign funds. The increased liquidity - mainly from overseas - and higher prices caused inflation to rise. Initially the government kept ignoring the rising inflation rate till it hit double digits. To curtail inflation, the RBI squeezed the supply of money by gradually increasing the CRR, SLR and Repo rates. Unfortunately, the sub-prime crisis in the USA hit the world's financial system like a whirlwind. Many of the FIIs who had lost heavily in the sub-prime derivatives markets, started to sell aggressively in the Indian share market.

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http://investmentsfordummieslikeme.blogspot.com The outflow of foreign money caused two problems. First, it caused a reduction in liquidity - which had already been tightened by RBI's policies. Second, it caused a fall in the value of the Rupee - which the RBI tried to stem by buying foreign currency, further reducing liquidity. The banks started feeling the pinch and started offering higher interest rates for deposits and, therefore, charging higher interest rates to borrowers. Industry found the easy-money taps getting closed - both in India and overseas, and started slowing down their growth plans. Speculators who borrow money to invest felt the cost of doing business was too high and started selling off. This compounded the selling pressure already exerted by the FIIs. The downward spiral in the stock market got exacerbated when small investors also started selling off. The several rate cuts that followed was the RBI's and governments rather belated effort to inject liquidity into the market so that banks could resume lending. That led to rejuvenating the growth plans of industries and eventually caused interest rates to go down. That was the first indication that the stock market was ready to start their next upward journey. But the spectacular rise from Mar ’09 onwards took a lot of experienced investors and fund managers by surprise.

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http://investmentsfordummieslikeme.blogspot.com Chapter 19: Why Michael Ballack is a role model for the better investor There are two kinds of people in this world - those who are crazy about soccer and those who aren't. For the latter, Michael Ballack is an outstanding German midfielder (who now plays for Chelsea in the English Premier league) with a rocket-like right foot shot. So what does Ballack have to do with investments? It's his left foot (not to be confused with Daniel Day Lewis' Oscar winning performance), with which he can kick the soccer ball just as hard and with immense power. Which brings us to the unresolved debate about fundamentalists (pun intended) and technical analysts. Fundamentalists don't understand technicals; technical analysts believe that all fundamentals are reflected in the price! Just as an international soccer star needs to use both his feet to pass and score, the better investor needs to learn about how to fundamentally analyse companies as well as technically analyse their price charts. Why? Fundamental analysis looks at ‘what to buy’; whether an industry is a sunrise or a sunset one, then identify companies within that industry, study their financial stability, growth rates, future plans, profitability, management quality, competitive advantages. After doing all that hard work for a particular industry, let us say for infrastructure, you make a short list of three companies: NTPC, L&T and BHEL. All are supposedly great companies. If you had bought them in December 2007, you are probably still losing money on your investment. Knowing ‘what to buy’ is not enough. Technical analysis tries to figure out ‘when to buy’, by identifying previously observed patterns in the price charts of stocks or the Sensex (or Nifty). The chart pattern of the Sensex in December 2007 would have indicated a severely overbought situation indicating an imminent fall. That was precisely the time when you should not buy. Neither fundamental analysis nor technical analysis can ensure profits in the stock market. By combining the two, an investor improves his chances. Use fundamental analysis to identify good stocks to buy. Then use technical analysis to find out the most appropriate time to buy. If the fundamentals are good but the technicals are weak, or vice versa, avoid buying.

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