Introducing Mr Market (aka Volatility) - Views on News from Equitymaster

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Introducing Mr Market (aka Volatility)

Apr 19, 2016

Investors hate wild swings in stock prices. That is, they hate volatility.

Given a choice, investors typically prefer fixed deposits over uncertain-but-possibly-higher returns.

Investing all of your money in fixed deposits might not be volatile. But sure as hell is not risk free. The Real risk lies in FDs not able to beat inflation in the long run.

How's that?

For a three to five-year period, current deposit rates are about 8% pre-tax. A tax rate of 30% gives a post-tax return of 5.6%. Expected Inflation is 6%.

You are actually losing money.

The BSE Sensex, on the other hand, has given average returns of more than 15% since inception. The ride has not been smooth though. The index has gone down sharply at times.

That's always when Investors begin to worry. But thinking about your net worth based on the latest stock quotes is not a right thing to do.

Your net worth is not what Mr Market will pay you today, but rather the intrinsic value of the stocks you own based on the fundamentals of the underlying business.

Volatility is not risk. Risk is defined more correctly as a permanent loss of capital.

We believe volatility provides opportunity. It allows us to buy more of the stock when the price falls.

Use this mental construct every time the volatility in stocks gets to you.

Imagine your need, greed, and desire to own the iPhone 6s. I am your only guy who has it in stock. I am a manic depressive, sadistic guy. I provide you with a daily quote for the phone.

One day I fight with my wife. I am annoyed and I meet you on the road and offer it to you for the peanuts you're holding in your hands. You BUY.

Now you use the phone - it's wonderful - but you want to sell... You spot me and ask what price I would consider buying. I give you a different quote every day.

One fine day, my wife demands an iPhone. I can't find it anywhere. I am annoyed and I meet you on the road again. I offer you 2x the price for your phone. You SELL.

Take advantage of Mr Market, aka volatility and his psychotic nature.

Some days he is really enthused while some days he gets clinically depressed. When he gets really enthused, you sell to him and if he sounds depressed, you buy.

Remember, Mr Market is there to serve you, not to guide you.

Expand your time horizon

Rather than being afraid of present uncertainties, broaden your time horizon. My colleague Richa has shown that, as your time horizon increases, the volatility of your returns diminishes.

Rephrasing Albert Einstein:

  • Out of clutter, find simplicity.
  • From discord, find harmony.
  • In the middle of volatility, lies the opportunity

Happy Investing!

PS: This is first of a three-part series on volatility. Stay tuned.

Devanshu Sampat

Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.

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