Mistakes that long term investors should avoid - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Mistakes that long term investors should avoid 

A  A  A
In this issue:
» Does inflation lead to higher growth?
» Why bullet trains could bankrupt the Indian railways
» Markets at life highs but investors exit Equity MFs
» Are China's debt concerns exaggerated?
» ...and more!

The world of finance is full of intelligent people. Be it the field of equity research, fund management, broking or financial planning, there is no shortage of advice given out by smart people. However, many a time even intelligent people make awful mistakes. This holds true for long term value investors too. At times, one may get carried away by his views about on interesting new companies as he may buy the stock thinking that the price is right only to be proved wrong later

Why does this happen to even the best investors who follow a good investing process? The answer can be found in our own emotional minds. No matter how good our investment philosophy and processes might be, in the end if we don't keep our emotions in check, we will fail as long term investors.

The field of behavioral finance studies how intelligent people make bad financial decisions due to their emotions overpowering their reason. Take an example of the simple principle of 'availability bias'. As investors, we tend to give more importance to events that have happened in the recent past. Since the information is fresh in our minds and thus readily 'available', we tend to think that the event may happen again soon. This is illogical but it is a very powerful factor affecting investor behavior.

When the last bear market ended in March 2009, there were very few people willing to invest. This was because the pain of the losses that they had suffered was still fresh in their minds. So they believed that the markets would fall more. However, the markets rallied back to its pre bear market high, by November 2010 and many people missed out on a golden opportunity to make money from undervalued stocks.

Yet another bias that hampers intelligent investing is called 'loss aversion'. This means that people refuse to take a 50:50 bet on winning ten thousand in three days versus losing the same amount in the same duration. Even though the probability of both events is identical, we would still prefer to avoid the loss rather than take the gain.

Our focus on extreme events like worst case scenarios also has adverse impact on our stock picking skills. When our emotions run high, we tend to think that rare events like a market crash of more than 20% could happen at any time. This sort of thinking will stop us from investing in a great company at the right price. By the time we realize our mistake, the stock would have run up a lot. These are just some of the many mistakes that have been identified by behavioral economists. Is there a way to avoid these mistakes? Yes! The very fact that we are aware of these biases is half the battle won we reckon. The other half is all about doing an independent evaluation of the stock and buying into it only after taking into account a sufficient margin of safety. After all, this is what value investing is all about.

We believe that the process of value investing, if followed correctly, will protect investors from most of their emotional biases and make the process of investing rational. After all, it has worked for the greatest investor of all time, Warren Buffet. It will certainly benefit us all.

Do you think that value investing is the best way to deal with emotional biases? Let us know in the Equitymaster Club or share your comments below.

By the way, Mark Ford, who is a very successful American publisher, entrepreneur and real estate investor, will be giving us a peek into his best wealth building ideas, thrice a week through The Daily Reckoning.

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01:41  Chart of the day
If macroeconomic indicators are anything to go by, Indian economy seems to be back on the recovery path. The trade deficit for the period 2013-14 has come down significantly. Currently, it stands at a three year low of US$ 138.6 bn. The trade deficit has shrunk, thanks to a series of import cuts. Overall imports are down by 8% YoY, led by 40% drop in gold and silver imports.

However, before one feels too good about the data, here are some other facts to take note of. The first is that India has failed to meet the export target in FY14. In the month of March, exports were down for the second month in a row and trade deficit touched a five month high. Until some time back, when everyone was crying over falling rupee, exporters were having a good time. Now with rupee showing some recovery with respect to other currencies and slowdown in manufacturing and weak credit conditions, exports are taking a hit.

The Government has been able to restrict, trade deficit thanks to unconventional measures like hike in excise duty for the yellow metal. However, the signs of a slowdown are hard to ignore. The economy is still surrounded by dark clouds. In short, what we are witnessing seems far from a sustainable recovery.

Lower bullion imports have helped contain trade deficit

Do you find the US Fed's policies of targeting higher inflation strange? Well, a gentleman who answers to the name of Larry Kudlow and is a distinguished commentator at moneynews.com certainly does. In fact, he has gone so far as to call the policy a total nonsense. He wants to know exactly how rising inflation is going to take the US out of its current state and into a full blown economic recovery. Well, he just reinforced what we've been trying to tell our readers all these years.

There isn't indeed a shred of evidence that a low inflation acts as the main obstacle to economic growth. On the contrary, there are many goods where demand soars only when their prices fall. Things like cell phones, flat screen TVs, washing machines, refrigerators etc are a prime example of this. Therefore to argue that high inflation is what an economy needs in order to get out of its current rut is absolutely a wrong assessment to make. What therefore needs to be done is not money printing but concerted steps towards increasing productivity. And some of the ways this can be done is by reducing tax complexity, making it easier for businesses to operate as well as keeping currencies sound. Since this was the same approach that worked in 80s and 90s in the US, there's no reason why it cannot work now.

The chief opposition party is fighting this election on the development agenda. Hence, it is natural that BJPs election manifesto would highlight the developmental changes it would effect if voted to power. One of the areas where it has highlighted to make major changes is rail connectivity. The BJP has proposed to build a high speed rail network of bullet trains across states if it wins the elections.

But the question is does India really need high speed bullet trains? And if it does, can India really afford it? The answer to the first question is may be yes. But when it comes to affordability, the math can turn the need of bullet trains upside down. As per an article in Business Standard, if such bullet trains are not subsidized by the government, Indian Railways could go bankrupt! Also, the fares on such trains would be so high that it will fall in line with air fares. In that case, why would someone opt for bullet trains if he/she can save more travel time via the aerial route?

The bottomline is that bullet trains should be a distant dream for India. The basic focus should be to better the present infrastructure like improving safety and sanitation facilities in trains. Expanding freight corridors is another area that needs attention. Once we overcome these basic problems, only then should we dream to emulate China or Japan in rail connectivity.

Investor participation - when gauged through investments in mutual funds - seems to be on a decline in current times. This we say because of the increasing amount of redemptions seen in equity mutual funds in the recent past. As reported in the Times of India, redemptions from equity mutual funds stood at a little over Rs 80 bn or US$ 1.3 bn during the month of March 2014. This in fact is the highest figure seen since September 2010. Investors do seem to be taking the opportunity of profit booking with the current upward market momentum in Indian Indices. As reported by the daily, the current run up is also providing investors - those who had invested in the market highs of 2008 and 2010 - an exit point. However, this development appears to be an anomaly given the usual trend of investors parking in more amounts when the markets move upwards. Given the many talks and debates over the sustainability of the current rally - as it seems to be driven by sentiments rather than fundamentals - it remains to be seen whether such investors are making the right moves or not.

China's growth has slowed down to 7.5%, a far cry from the 10% growth it was used to before the 2008 global crisis unraveled. Post the crisis, indiscriminate lending soared and most of this found its way into the property market fuelling concerns of a bubble forming there. The Chinese government has realized the risks of this and since then has been making efforts to put the brakes on lending. However, concerns still prevail with respect to local debt and how this has substantially increased. Indeed, as per an article on Bloomberg, the liabilities of local governments increased by 67% to 17.9 trillion Yuan as of June 2013 from the end of 2010. The Asia Pacific director of IMF opines that these concerns are exaggerated because the debt is in local currency and there is room for the Chinese government to react. But it goes without saying that debt overall is a problem in China. And even if there may not be a crisis of epic proportions, the Chinese government can certainly not lend at the furious pace at which it had done so in the past.

04:50  Today's investing mantra
"We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely." - Warren Buffett
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3 Responses to "Mistakes that long term investors should avoid"

parimal shah

Apr 16, 2014

To say that Indian economy seems to be back on the recovery path is incorrect. All one can say is it is in a slightly better shape.
Please note:
- The CAD is contained artificially by curbs on yellow metal imports - (that increases its smuggling)
- The subsidy bills have been pushed to next fiscal
- The PSUs have been drained of their cash balance.
These are obvious. There will be many covert actions that will cause greater pain to the next govt - whichever party and in whatever form of coalition or otherwise.
- Bullet trains are necessary and no need to subsidize it. Just as airlines are not.



Apr 14, 2014

The concept of controlling inflation by RBI has to be appreciated even though exporters cry foul and say they are suffering. It is seen in India that once an item is exported the domestic cost of the item increases and the item can not be afforded by Aam Admi. People who earn or benefitted from export activity spend their money lavishly and create an impression that items like commodities,food,vegetables,fruits shoots up. The same price paid by export benefited citizens has to be paid by others. Sometimes this creates artificial scarcity and hence prices are increased by sellers or traders. In this way growth is not attempted but inflation increases without any growth. This is to be compared with the idea that growth is accompanied by inflation.

Like (1)

Kishore J. Katara

Apr 14, 2014

I disagree with your views on Bullet Trains.I have been to Japan and though even there the prices of the train ticket is nearly same as that of air ticket,people prefer the train as it takes one right into the business district whereas the airport is located far away entailing a travel of another hour or two each way.Also, for flights, one has to check in at least an hour before and at the destination point,wait for the baggage to come.So in all bullet trains will save time even if the cost is same as air ticket.

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