Buy low, sell high. This is probably the most basic rule in investing. But, buying at lows is a difficult task. Timing the market is not something that investors should aim to do.
But then how would one know when to enter the market? This is where the aspect of valuations comes in.
Unlike other things that people like to buy i.e. at cheaper prices or discounted rates, the mentality of retail investors seems to be quite the opposite. Sure, the volatile markets can make one jittery; which is why Indians like to put money in relatively safer instruments such as fixed deposits and post office schemes.
But the fact of the matter is that over the long term, stocks have the tendency to outperform all other asset classes. But that would not be the case if one enters the market when valuations are high - which is why many investors have burnt their fingers, lost a lot of capital and thereby, lost faith in stocks.
Having said that, the short lived memories of investors tend to bring them back to the markets. But with most retail investors, it seems to be the case when markets have moved up substantially. In other words, when they see stocks moving up, they don't want to miss out on the rally, and start pumping money. By that time, it gets too late as the valuations tend to move up as well, thereby making stocks quite expensive. Essentially, what this leads underperformance or losses over the long term.
As Prashant Jain, Fund Manager at HDFC Mutual Fund had mentioned a while back "A vast majority of investments in mutual funds have come in after the markets have gone up substantially and when the markets are expensive. On the other hand, redemptions are more at lower P/Es. Such an approach to investments does not lead to good returns."
As per the Business Standard, Rs 470 bn (net investments) were invested in equity schemes during FY08. In that year, the average forward price to earnings ratios stood at 20.4 times, which is considerably higher than the long term average. Thereafter, when the market declined, it brought the P/E to levels of about 14 times. However, the inflows declined and were eventually surpassed by outflows. Again in FY13, when valuations stood at levels of 14 times, the net outflows from equities stood at a high level of Rs 146 bn, which was a record high.
As per Mr. Jain, investors should practice low P/E investing. This short statement is pretty much the best conclusion to this write up. For anyone hoping to make money in markets over a long term, buying at expensive valuations could lead to underperformance even during boom periods.