A ‘not-to-do’ list for 2008 - Views on News from Equitymaster

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A ‘not-to-do’ list for 2008

Dec 31, 2007

As we close in on the year 2007, there is a flurry of predictions and guesses, both educated and uneducated, with respect to the movement of markets in general and stocks in particular during 2008. In these times, as you, the investor, are bombarded with things to do in the coming year, we believe that, at the same time, a ‘not-to-do’ list shall also serve a meaningful purpose. As such, here is one such list that our readers can prepare for themselves and benefit from investing in stocks over the next 366 days, and beyond.

  1. Not to give in to greed and fear: This is an important point, which you, as an investor, must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals. Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back. It is apt to note here what Warren Buffett, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, "It means we miss a lot of very big winners but it also means we have very few big losers.... We're perfectly willing to trade away a big payoff for a certain payoff".

  2. Not to time the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers' end. In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again (and will be in 2008). In Benjamin Graham's words, "Basically, price fluctuations have only one significant meaning for the 'true' investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market".

  3. Not to act based on rumours and sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investor’s portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffett, "Be fearful when others are greedy and be greedy when others are fearful".

  4. Not to attach emotionally with stocks: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price. However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company's performance may improve for the better and the stock would provide an opportunity to exit at higher levels. Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffett's words, "Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks".

  5. Not to borrow and buy stocks: This behaviour is typical in times of a bull run when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards). However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements. In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.


Note: This list is compiled from an article that we had originally written in January 2005


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