Wednesday, August 31, 2011

The Orchard Street - Discipline

We invest based on immediate recent memory. If the market has been range bound last 6 months, we would expect the same in near future. If in the last fortnight, it has gone down, we predict further fall. We read a pattern in the market where nothing of that nature ever exists. Many investors turn bullish after as little as a few weeks of bullish trends and good returns in the stock markets. What we seek to see as pattern in trends or prices are just random variations. What happened recently will determine what we think is likely to happen in future. If a child has failed once, we believe he will fail again. Blame it on the mental wiring. This limits our investing capability.

One way to escape falling into this mental trap trap, is to have a discipline. It has been proven time and again that you do not need great financial IQ to succeed as much as discipline. Sheer discipline has helped this friend to do better than the average markets. He has bought about 30 so stocks, mostly the ones you would see as part of the Nifty50. This ensures basic fundamentals are taken care of, as such no elaborate research is being done by my friend who is an in-active investor and keeps a 9to6 regular hectic job. Every month after he pays off his bills, he decides to invest the balance surplus salary. What is interesting is how he allocates his money and on what stocks. His formula is very simple. Amongst the 30 odd companies he holds, he checks around the 1st of every month to see which stock has grown by 25% from his investment in it. Quite unlike I would prefer, he goes ahead and allocates money into the very stock that has hit this threshold of 25% appreciation. In the orchard of fruit trees, the ones that grow fast and well, get more water and manure. he calls it 'watering the plants'. Very simple, easy to track and no sophisticated tools to manage. Yet very powerful. I would not recommend this for all, this suits him as he has less time for research but prefers to invest himself.

What is material in the market, is some form of discipline. Like watering the plants. I was shocked to learn that this very well known financial wizard invests only in Index ETF. This baffled me and gave a new perspective to my knowledge and learning. When there are so many established themes of investing like value, special situation, contra, growth, dividend that fund managers have been using for many many years, why would a pro not benefits from them? And merely invest in the index? When I discussed it with him, he called it a Zero Sum game. He does not handle any fund now and is engaged in sharing his experiences & knowledge.

We invest in a world where there is constant race to identify multi baggers and disproportional wealth creating ideas. We base our prediction either by extrapolating some one Else's past experiences of multi bagger or specific stories of huge wealth creation. In this Pro's perspective, those real experiences of making huge returns are just black swan and happens with out any foresight. They are never planned. But if you ask that successful investor, he would say he knew it all along. This is called hindsight bias. We go back in history and justify how well we read the future even when this is not true. This is a trick the brain plays and limits our investment capability.

There is great news for investors who have patience. Today there is excess fear around stocks of banks, capital goods, cement, real estate etc.These have been beaten in the markets and are now attractively valued with low P/E. If India can grow at 7% for the next 3 years, which seems possible, we must seek out these opportunities. While there is significant margin of safety, one can not predict if this is the bottom or there is more to the downside. As we say, it is impossible to time the bottom of the market.

As Benjamin Franklin said “If a man empties his purse into his head, no man can take it away from him. An investment in knowledge always pays the best interest.
Best Regards,