On a social media group meant to educate people about personal finance, we had some members promoting direct stock investing. It all started with one person asking recommendations for a brokerage account. Finally, after she opened the account, her next obvious question was on stocks to buy. At this point, I asked her and others who gave recommendations a few questions: how were they choosing the stocks? Top-down, bottom-up, which sectors, did they evaluate the financial statements, what ratios they considered and, most importantly, about valuations. Her answer was that she wanted to know the names of stocks which can double quickly!
The lure of quick money
And this is the problem today. People are focusing on what others are doing, in an area where the outcome is out of control and are relying on luck to make money rather than focusing on the process to achieve this goal. This is akin to wanting to lose weight without any effort or thinking one can run a marathon without training for it. Rather than focusing on the what, investors who are serious about building long term wealth need to focus on the how. While the goal provides direction, following a process is best for making progress.
It is not that a process will always have the right outcome. However, a process means fewer distractions, ability to deal with mistakes and satisfaction in the pursuit. In the above case, maybe the expected returns may materialize, but how would the lady react when markets are down or if there was negative news about the stock. If she had researched the stock, certainly she would be able to handle volatile times better. Further, one may not feel as bad in case of an unfavourable outcome.
Following a process
So how does the “How” work?
-The ‘double my money’ goal is a good start and needs to be complemented with a scenario analysis on what could go wrong and how it will affect the portfolio. The first step is to always identify the risk and its impact on the portfolio’s health. Do not assume that stocks move in a single direction.
- Think about the metrics of success. What drives stock performance? Does the stock you are investing in satisfy those parameters? Similarly, if you are choosing a thematic international fund that invests in clean energy and related businesses, what are the factors which will help these businesses sustain? Do not get swayed by narratives.
-What is the cost to get to the outcome? I see investors jumping into foreign stocks, PMS, small-case, structures without a thought on the costs. The costs of these investments are more than double that of mutual funds, not to mention the extra paperwork and tax compliance, which are cumbersome and time-consuming. The time lost is the biggest cost.
-How will you deal with mistakes? Investment choices do not always work out. These situations provide great learning on what to do better or what not to do. I had invested in many penny stocks in 2007, only to exit at a 70 percent loss in 2008. This experience made me realize that I am better off investing in a small-cap mutual fund rather than on my own.
-Keep improving as an investor. Are you the same investor as you were five years back? Making continuous small advances can make a big difference. Five years back, I had a portfolio of more than 30 stocks, 15 mutual funds and some tax-free bonds. Over the years, I have brought this down to 5 stocks, 6 funds and a few tax free bonds. I mainly invest additional amounts in the same holdings.
-Do not forget the simple winning strategy: diversification among asset classes, keeping costs low and tax efficiency high, not paying attention to the daily noise in markets and rebalancing annually.Success needs a process. As we approach the calendar year end, check/ build processes in your investments.