The 3 most dangerous words in investing - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The 3 most dangerous words in investing 

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In this issue:
» Is the commodity super cycle over?
» Aadhar scheme gets a thumbs up from World Bank Chief
» Going back to 8% growth soon looks like a distant dream
» Is macroeconomics necessary to succeed in investing?
» ....and more!

Imagine you enter a store full of antique artefacts with the intention of purchasing few of them. However, there's a problem. None of the items have price labels. In other words, you are free to estimate the price you want to pay for these pieces of art. Well, some kind of phobia is sure to grip you. After all, you don't want to end up overpaying for most of the stuff you bought. Now imagine that just one of these artefacts has a price label on it? We bet you'll start pricing all the other items in relation to the price of this one piece that has a price on it. Mentally, you'll feel a lot better even if the item that had a price on it was way exaggerated in the first place.

What we just saw is one of the biggest tricks our brains play on us. Human beings crave for some kind of reference points. And if that's not available, their minds just get paralysed irrespective of whether the reference point is right or wrong. How often have we bought clothes at 50% off even though the original price was way too high to begin with? Here, the original price acts as an anchor for our minds and thus we end up feeling good about it.

Well, if this anchoring bias shows itself up at all places, how can investing be left out? In fact, nowhere it is as rampant as in equities. Have you ever got the feeling of 'I missed it' whenever a stock that you identified as good investment goes up a lot? The feeling is fine we believe. But what is not fine is that you stop doing any further work on it and let the opportunity pass by. Because it is here that you show all signs of getting seized by the anchoring bias we just discussed. You wrongly assume the investment from the point of view of the price at which you first identified the stock. However, for all you know the stock would still be a good investment. Thus, to overlook an investment just because you witnessed the stock trading at much lower price earlier is a big, big mistake to make we believe. In fact, the celebrated fund manager Whitney Tilson calls the 'I missed it' feeling as the three most dangerous words in investing.

Fortunately, the problem is not that hard to overcome. All one has to do is make an attempt to forget the original price of the stock and conduct one's research afresh. And if the stock still ticks all the right boxes, one should go ahead and make the investment. Not doing so would be a cardinal sin we believe.

Have you suffered from the 'I missed it' syndrome in stocks? Please share your comments or post them on our Facebook page / Google+ page

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01:19  Chart of the day
Last week, we saw the best performing sectoral indices since March 2009. The consumer durables sector, which is up more than four-fold since then, was a clear leader of the pack. But which stocks within this space have gone up the most? Well, today's chart of the day has an answer to that question. It highlights the best performing consumer durables stocks since March 2009. As can be seen, Symphony which is up a huge 46 times since the lows of March 2009, has left all the other stocks far behind. However, we would like to mention that investors should never invest in the stock with the intention of making such huge returns. All they need to focus on is the fundamentals and the competitive advantage of the business and let the price take care of itself.

Source: Ace Equity

Most of the successful value investors have a couple of things in common. One, they do not waste too much time and effort analysing macroeconomic data and indicators. Two, they have a very keen understanding of market psychology. By staying away from the herd mentality, they are able take advantage of the follies and excesses of the markets. One of Warren Buffett's most famous quotes highlights exactly this point: "I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful."

We came across an interesting article by Mark Dow, a money manager who echoed the same view. Before venturing into the markets, this gentleman had worked at the US Treasury. He even did a tour of duty at the International Monetary Fund (IMF). As such, it goes without saying that Mr Dow did have substantial exposure to policy economics.

But when he started managing money, he realised that one could be very successful even without knowing too much about macroeconomics. On the other hand, he became an ardent follower of behavioural finance, a relatively new field that focuses on the psychological aspects of the markets.

We completely agree with Mr Dow on this. The principles of value investing are completely in sync with behavioural finance. By understanding the psychological tendencies of the market as well as our own biases and misjudgements, we can pave our way to riches in stock markets.

A promise during our grandfather days was dutifully honored. But a promise from a politician be it in any era will always leave a question mark in one's mind as to whether it will be honored or not. Be it a promise related to eradicating poverty or restoring growth. They are always meant to be broken. Make sure politicians will never make a promise to eradicate corruption because they thrive on it.

Let us discuss one promise that the government is pretty vocal about these days. It relates to restoring growth. While it can't be deemed as a promise in strictest sense, faltering growth has made the government circumspect. From an era of 9-10% growth, we are at 5%. Current account deficit is also at intolerable levels. In order to restore confidence amongst masses, the government has expressed confidence that it will achieve higher growth rate in future. It is making an indirect promise of returning to 8% within the next 3 years. But will it be able to honor it?

For that, first we need to know why the growth faltered in the first place. If we know the reasons behind it, we can take corrective action. Now, growth faltered due to lack of reforms, wide spread corruption and unnecessary delays in getting approvals for large projects. Monetary policy measures to restore growth are not suitable because of high inflation. Hence, the only solution to restore growth is to find an answer to the discussed problems. While government has taken some steps in this regard, one cannot expect the country to be corruption free in the next 3 years. And as long as corruption thrives, which is an impediment to reforms and policy making, 8% growth is a distant dream.

He is called George Soros' alter ego. But the man on whose head rests such a laurel is rather low profile. He answers to the name of Stanley F. Druckenmiller. And despite having a virtuous track record in managing Soros' Quantum Fund, Druckenmiller is hardly a voice often heard. So we were all ears when he recently cited his opinion on commodity prices.

As per an article in Barron's, Druckenmiller believes that the gains in commodity prices over a decade until 2011 (2002-2011) were an anomaly. That 50% of all global demand from 2002 to 2011 came from China was itself an impending risk according to him. Now that level of investment in China has abated, the downside is underway. What is worse is that commodity producers have ramped up production expecting demand to pick up. But the time they realize their mistake, it will take three to five years for the demand to catch up with excess. And hence it is only a matter of time before commodity prices start reflecting this huge demand supply gap.

There was a time when US government debt was synonymous with safety. But given the mess that the US in, US Treasuries slowly and surely are beginning to lose the attraction they once held. The latest to take a cautious view on US debt are university endowments. They have scaled back their holdings of Treasury securities from as much as 30% in 2008-09 to zero in some cases, as per an article in Financial Times.

The perception towards US debt has undergone a sea change. At one point there was certainty that this debt would be repaid. But with interest rates so low, it is feared that bond prices would also plunge. Too much monetary easing by the US Fed had led to the creation of money supply all of which has contributed to the rally in US Treasuries and stocks. But the fundamentals have not changed. The US economy continues to remain weak and a heavy debt burden continues to saddle the government. Thus, those moving money away from Treasuries could very well be making a smart decision indeed.

The Aadhar card was introduced by the PM along with Nandan Nilekani as an optional card. What started out as a simple identity card that would be provided to all Indians, turned into a card that would benefit the poor. And now into a card mandatory for receiving all/any benefits from the government. Many government aids do not reach the needy and the poor. By providing a clear proof of identity, Aadhaar will also facilitate entry for poor into the formal banking system. Aadhar will also give migrants mobility of identity. Although the Aadhar idea is excellent, its implementation still remains a challenge.

However, despite its hurdles, World Bank feels that the Aadhar card is one of the best examples of integration of technology for social welfare use. The bank opines that the card will enable the country to eradicate poverty. Well, we really hope the scheme is able to live up to such lofty standards.

Meanwhile, indices in the Indian equity markets traded lacklustre today with BSE-Sensex higher by around 25 points at the time of writing. Pharma and oil and gas stocks were seen under bit of selling pressure. While Asian stock closed mixed today, European indices are also trading mixed.

04:55  Today's investing mantra
"The time to reflect on your investing methods is when you are most successful, not when you are making the most mistakes" - Sir John Templeton
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5 Responses to "The 3 most dangerous words in investing"

Rahul Kumar Srivastava

May 10, 2013

Just beware of cunning, criminal minded and greedy entrepreneurs



May 9, 2013

very much enlightening, for me, a person who made many mistakes.


R A Raichur

May 9, 2013

Thanks for bringing this frailty of mind to fore. A corollary to this is what i have gone through.. i had identified good stocks , bought them , seen them going up but then i am not comfortable in investing more in them.. feeling the price too high to buy NOW.. though the stocks have risen further and further.. My mind is anchored to the OLD PRICE still ..


Dinesh K

May 9, 2013

very true, i missed it are the three most dangerous words in investing. if the basics are right, understanding proper, calculations checked and filters for stock rechecked, facts verified,and management has the right thinking to grow the company, outshine it will, may be time effect will play its role, but fundas rule in the long term. that is What Sir Warren Buffet advocates. pick leaf of his understanding and going should be great.abudant patience and self belief advocated to be pratised. In the process if you fail or something does not turn out as envisaged, drop that item from your daily check and move on. dear in this market everyday is a oppurtunity so don't ever say or feel'I missed it', because research has inbuilt definition that you should re-repeat searching value compared to price and go on., without feeling messed up. all the best


Krishna Setlur

May 9, 2013

About the Aadhar: Iam surprised that the World Bank chief gets fooled by the hype around Aadhar. It is one of the biggest scams yet to be discovered as such, imho! The initial intent was to provide some quick and effective means of providing and authentic and official identity document to those (especially the poorer people in our country) who had no other way of getting a formal identity document. By making this mandatory, it has introduced one more layer of bureaucracy into an already bureaucratic ecosystem, and also ensured that Nandan and his cronies (yes a lot of implementation is rumoured to be handled by companies run by his cronies) continue to have their hands into the public coffers, even more than ever!

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