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Do you know this 'Do Nothing' secret to investing?

Feb 26, 2015

In this issue:
» Why banks are not cutting base rates despite a cut in repo rate...
» Ever heard of creditors paying to lend their money!
» List of loss making companies at a year high
» ...and more!

00:00
Do you have any idea about the most dangerous enemy you will run into while pursuing investment success? Well, it's none other than your own self! Yes, you heard that right. Apparently, one's biggest enemy while investing turns out to be the person doing the investing himself. You see, we humans have just not evolved in a way that makes us natural at investing. On the contrary, we practically need to invert most of the default settings in our brains if we have to have any reasonable chance of becoming a successful investor.

And nothing exemplifies this better than this study that was done some years back at the famous asset management firm Fidelity. The study involved finding out which of their customer investing accounts had performed the best. Any guesses what the results were? Well, the best performing accounts were the ones where people had forgotten that they even had Fidelity accounts! Yes, the best performing accounts ended up being the ones that lay dead for years or even decades at a stretch with absolutely no buying and selling of shares in them.

We hope you understand the point being made here. The most successful investors at Fidelity were the ones that did not take any stock related advice from the so called stock market gurus. Nor was there any importance given at all to quarterly or half yearly financial results. And last but not the least, no effort was made towards market timing. And yet, despite of all this, their portfolios vastly outperformed the more active ones.

Is there a lesson here? Is this the key to successful investing that has been eluding most investors so far? Looks like none other than Warren Buffett shares the same point of view. After all, he is heard to have said on quite a few occasions that it is not activity but inactivity that strikes him as intelligent behaviour in the field of long term investing. Besides, he has also commented on his investment style which he labels as lethargy bordering on sloth.

In fact why just Warren Buffett. Many other successful value investors follow the same tenet of not paying too much attention to the day to day gyrations of stock prices. They instead focus totally on the long term with minimum churning of portfolio and absolutely no attention to market timing.

Mind you, we are not batting for a buy and forget portfolio here. Of course, stocks that have gone up too much in price need to be replaced with ones that have significant upside left from time to time. However, things like trying to invest in the next hot sector or buying and selling at every small development may actually end up causing more damage than doing anything beneficial for the portfolio.

Therefore, as highlighted in the beginning, the idea should be to turn off most of the default settings in the brain. And let the power of compounding and that of minimising transaction costs do its work.

What do you think? Do you agree that doing nothing most of the time is a better approach to investing than frequently moving in and out of stocks? Let us know your comments or share your views in the Equitymaster Club.

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02:50
  Chart of the day
Looks like there is no respite yet from the number of loss-reporting listed firms. As the chart of the day highlights, the number of listed firms that have reported losses during the December 2014 quarter have come in higher than the September 2014 quarter and also the quarter preceding it. All this at a time when indices are scaling new highs and sentiments at the most positive they have been in recent years. So what gives? It should be noted that stock markets have this tendency of not factoring in the current but the future developments and therefore it looks like the expectation is that of a much improved showing from India Inc.

Well, with a little help from the Government, this can indeed be a possibility but betting too much on the same happening could be fraught with risks we believe. Consequently, expectations need to be tempered down and until the data such as the one highlighted in today's chart of the day does not show a sizeable improvement, it will be better to stay cautious we reckon.

No respite in number of loss making firms

03:15
After RBI cut its repo rate in January expectations were high that banks would soon follow suit and cut their benchmark lending rate. However, surprisingly only 3 banks have reduced their base rate till now! And the biggest stumbling block for their inability to cut rates has been RBI itself.

Banks typically set their base rates depending upon their cost of funds. Earlier banks arrived at their cost funds by figuring out highest interest rate it paid to its deposit holders. The size of deposit base did not matter. Only the interest rate that was paid mattered. However, as per the new directive of RBI banks have to arrive at their cost of funds depending upon the interest rate it pays to its largest base of deposit holders. Say for example, a bank has its highest deposit holder base between 2-3 lacs. In that case, it should use the cost of funds which it pays to this category of deposit holders in order to arrive at its base rate.

Many bankers believe that this move is particularly troublesome. This is because the largest deposit holder base does not remain constant. In one month, a bank may have highest deposit base between 2-3 lacs and in another month it could shift to any other category. And the irony is that once you choose a particular methodology (read base) to calculate your cost of funds you cannot change it for 3 years.

As such, most banks have been circumspect to reduce their base rate. If after reducing the base rate, their cost of funds rises due to a shift in deposit base banks shall get trapped with lower spreads. We reckon RBI should find a solution to this else banks would not be keen in reducing their base rate. And the prospective benefit of lowering the repo rate so as to reduce borrowing cost for corporates & individuals would fail.

03:45
Let's stick to the topic of borrowing and lending. In Germany, a very weird thing happened recently. The German government came out with a bond issue that had negative yield. This means that investors will effectively lose money if they invest in these bonds issued by the German government.

On the face of it this may sound foolish. And no investor would ever buy such bonds. However, the fact of the matter is that the German government was able to sell such bonds worth Euro 3.3 bn with investors lapping on to the issue happily!

Let's understand why investors were happy to lose money on lending to the German government. Basically, investors fear that inflation may fall in Europe. In fact, many are worried about a deflationary scenario. And in deflation the value of these bonds would fall less than other asset classes. Plus, there is a security of principal repayment since they are issued by the government. Hence, most investors have bought into the issue.

This shows the kind of economic divergence prevailing in the Western world and India. The former is suffering from deflation and is more worried about protecting the value of its assets from falling. However, the latter is more worried about rising inflation which is eroding the purchasing power of people. Neither situation is better. An ideal scenario is when inflation rate hovers in the range of 3-4% which neither hurts consumers nor does it presents risk of deflating asset values.

04:30
The Indian stock markets are trading weak today. At the time of writing the BSE-Sensex was trading down by around 238 points, while the NSE-Nifty was down by 70 points. Losses were largely seen in IT and healthcare stocks. However, most Asian markets were trading in the green at the time of writing. European stock markets, however, opened mixed today.

04:50
 Today's investing mantra
"Only when the tide goes out do you discover who's been swimming naked" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Jinesh Joshi and Rahul Shah.

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5 Responses to "Do you know this 'Do Nothing' secret to investing?"

anil soni

Feb 28, 2015

I personally feel that Buffett strategy is not applicable for our markets because
our markets are not matured enough and overdependent on FII flow , highly manipulated , issue of corporate governance,very few companies and managements are genuine even WARAN BUFFETT never invested in any Indian companies and if he will come here he will close his operation within a month

Like (1)

kpthomas

Feb 27, 2015

our trade gets in the wrong direction very often day trader lose everytime he goes against the trend SO less trade more profit

Like (1)

RK JHA

Feb 27, 2015

The 'DO NOTHING' ASPECT OF INVESTING holds true for investors who select stock for their portfolio judiciously and are NOT short term / day trader.

Second point I would like to make is one must keep close watch on the stock held in the potfolio. There is a saying "Do not put all your eggs in one basket.Even if you do please make sure to watch the basket carefully."

Like (1)

Ananda Dhara

Feb 26, 2015

A very exciting and rewarding writing.

Like (1)

krishnamurthy

Feb 26, 2015

It is my experience that keep purchasing only one or two at a time of good shares and not selling is the best option for me.

Like (1)
  
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