10 Commandments for investors.

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Uncertainty is another name for the Stock Market. In fact, we have faced  12 bear markets in the past 25 years. However, 2020 was a year when investors experienced almost the full range of market behaviour, from the fastest fall in recent history to the sharpest recovery on record.

With a bit of certainty now back on track, it’s a good time to review what lessons we have learned from it to navigate future crises.

Here are my top ten lessons for investors:

1) Don’t Follow the Crowd

The crowd tends to be a poor advisor when it comes to financial decisions; it panics easily, and its actions are often contrary to logic and common sense.

A sober and crowd-independent judgment is a useful asset in volatile markets.

2) When You have to Shoot, Shoot, Don’t Talk

A well-known dialogue from an all-time great movie “The Good, the Bad and the Ugly” (1966) is most suitable for investment.

What is it?

When you have to Invest, Invest, Don’t Speculate.

3) Be Prepared for the worst

Nothing is going forever so the Bull markets also won’t last forever. This simple rule is forgotten by very investors, especially during long periods of steep price appreciation. 

Before the 2008 US Real Estate Crisis, real estate prices rose for a long time. It got to the point that people took out loans and bought a real estate that they otherwise couldn’t before in hopes that the value of their property would rise so much that the loan would pay itself off. 

Whether it’s about dot-com stocks, the housing market, or Dogecoin — sooner or later, any growth will be followed by a decline, which may or may not be catastrophic. 

Keep this possibility in mind and don’t get lost in the Euphoria of Optimism. 

4) Beware of market forecasts, even by experts.

As 2008 began, strategists from Wall Street’s 12 major firms forecast the end-of-the-year closing level and earnings of the Standard and Poor’s 500 Stock Index. On average, the forecast was for a year-end price of 1,640 and earnings of $97. There was remarkably little disparity of opinion among these sages.

Reality: the S&P closed the year at 903, with reported earnings estimated at $50.

Ignore the forecasts of inevitably bullish strategists. Bearish strategists on the stock market’s payroll don’t survive for long.

 

If stock market experts were so expert,
they would be buying,
not selling Advice.

5) Never underrate the importance of risk management.

Investing is not about owning only Equity Funds. Nor are historical Funds returns a sound guide to future returns. Virtually all investors should park some money in their portfolios in the form of high-grade short-term or Ultra Short-term debt Funds. Investors who failed to learn that lesson fell on especially hard times like in 2008-09 Financial Crises and the 2020 Pandemic disruption.

How much in Debt? There is no thumb rule for that. The best way is to become conservative when the market risk is high and be aggressive while the market is at a lower risk. The impact of negative returns from equity while disruptions will be lesser, because our majority of the investment will be in debt, and will also be compensated by debt funds returns.

With all the focus on historical returns that greatly favour Equity Funds, don’t ignore Debt Funds. Consider not only the probabilities of future returns on stocks but the consequences if you are wrong. Be prepared for the worst.

We cannot Manage the Risk just by being an Optimist

See how the Value of your STP has gone down in just a few days from 43,75,565 to 28,02,807 = 15,72,758 (36% in less than 36 Days).
All this happened because of ignorance of Risk Management. If you calculate Real Return it would be negative because average inflation was >7%.

Without thinking about the possible worst situation, Risk Management is not possible.

6) Mutual funds with superior performance records often falter.

As we have seen in the above Infographics when disruption happens the highest return-generating equity funds are getting the worst hit. Only time will tell whether the disappointing shortfalls experienced by these and other funds will be recovered in the future, whether the skills of their managers have atrophied, or whether their luck has run out. Whatever the case, chasing past performance is all too often a loser’s game. 

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

—Warren Buffett

7) Be patient.

And when you are tired of being patient, be patient some more. An investor buys a stock or mutual fund. At its extreme, impatience looks like this: The investor waits until the next day and checks the price. If the price is higher, the investor “knows” he has chosen a winner. If the price is lower, he “knows” he picked a loser. 

To lose patience is to lose the battle

8) Never forget your Risk Appetite

People generally get confused between risk appetite with risk management. Risk management is the regular analysis of risks, that may face in the future. Risk Appetite is nothing but How much risk an individual can bear. If we cross the border it may ruin our entire financial life. So the risk should be taken within the spectrum of our Risk Appetite.

To be a successful investor, you don’t need to take excessive risks and be involved in all sorts of financial instruments. You need to understand your risk appetite and understand a few asset classes well. Stay within your boundaries, and your wealth will grow at a decent pace.

9) Do your own Research

Never depend on hearsay and decisions of your neighbour, friend, relative or tips from the media or your stock broker and invest in stocks. It may seem easy but could amount to gambling.

Being an informed investor while investing, your hard-earned money needs you to ensure that the investment would meet your financial goal. This could be done through research from various sources.

Buffett gives two key pieces of advice when evaluating a company: First, look at the quality of the company, then at the price.

If a company isn’t a quality company, don’t buy it just because the price is low. Bargain-bin companies often produce bargain-bin results.

10) Beware of financial illusions.

Why? Because Our financial system is driven by a giant marketing machine in which the interests of sellers directly conflict with the interests of buyers. The sellers, having (as ever) the information advantage, nearly always win.

Take your investment decisions based on intuition rather than illusion.

We had already discussed this in the article “How is the Illusion created in Financial Market“

We can’t say that we haven’t been warned about the perils of ignoring the past. More than 2,000 years ago, the Roman orator Cato noted that

There must be a vast fund of stupidity in human nature, or else men would not be caught as they are, thousand times over, by the same snares.