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Tuesday, April 22, 2014

What should you do rising Stock Market?

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Here are the six things you should keep in mind if you want to build and secure long-term wealth


If it were not for the market crash and the prolonged bearish phase, asset allocation would have remained in textbooks. In the past six years, investors have learnt that they can make money in gold, and short and long-term debt too. They also toned their equity return expectations from an unrealistic 30% to a conservative 12%. Just as they were beginning to see the merits of diversification, the current euphoria has taken over. This is the reason I feel the need to strike a cautionary note.


Long-term wealth is built by being strategically focused. Some timely tactics may add a few percentage points of gain, but the fundamental principles are the same. Let us go through the top six dangers for common investors in a market driven by euphoria.


First, IPOs will make a comeback. Remember, these are issues that are sold amidst media and marketing hype by companies that are keen to get a good pricing from their merchant bankers. Do not assume that IPOs are intended to make the small investor rich. They are opportunistic capital raising programmes in which good, bad and ugly issuers participate. One may not be able to tell the difference. If you must, invest a small amount. Better still, limit the capital allocated and book it out on listing and rotate it. Long-term wealth is too precious to be built on the basis of speculative bets about unknown companies.


Two, derivative strategies will be hawked afresh, especially if you are an HNI and are always asking your broker or private banker for something new. In a market flush with enthusiasm, smart strategies that promise a bigger bang for the buck will be popular. It may seem that derivatives are a faster route to making money. If you are a veteran in derivative trade, you have reasons to feel gleeful, but if you cannot tell the straddle from the strangle, keep away. The rule that you should not invest in something that you do not understand, always holds true.


Third, leverage will make a big comeback. Your broker will encourage you to use margin money to trade. Your private banker will be willing to lend money against your shares, funds, bonds and deposits. Your neighbourhood NBFC will offer you loans to subscribe to the next IPO. Your bank will tell you that you can unlock the money in your assets by taking a loan. While borrowing seems like a great route to building assets, it is also ruinous if you do not earn enough to repay. Taking a risky bet with borrowed funds is a double-edged sword, except when the asset that is being funded with the borrowing can only rise in value. Since there is no such asset, borrowing should be determined by your ability to repay, not by your bet on the asset.


Fourth, you will hear that it is different this time. There will be new theories floating about, telling you why an improvised insurance product is better; or how a multi-thematic fund is the newest thing on the block; or how the companies to buy are the ones that are likely to be taken over. The media will fuel these ideas based on a few instances and present to you the case for a new India, where it is now easy to make money based on this new insight. When it comes to investing, most rules are as old as the Bible. There really is nothing new and you will understand this truth much after you have suffered for your ignorance. A business that is run with an eye on deploying capital sensibly in growing assets, steered by a competent management, will come out at the top. This simple idea will be camouflaged by newer theories about successful businesses. Do not mistake the rising stock price for the fundamental strength of the business.


Fifth, do not make investment decisions as if you will miss the opportunity if you do not act. Anything presented to you as an investment proposition that you have to decide on immediately, and sign off as fast as possible, has to be bad. Long-term investing is about considered decisions that evaluate merits and risk, and these are never taken in haste. Steer clear of 'exclusive' or 'privilege' tags for investment propositions. Also recognise aggressive selling tactics as a sign of desperation. Recognise that full-page ads for property that has been fully sold out has to be a misleading tactic. Why spend if there was nothing to sell? Deals will be repackaged and discounts disguised only when there is inventory to be cleared.


Sixth, recognise the huge gaps in the institutional structure of the financial markets. Many promoters have a web of companies. Corporate governance is weak as boards are mostly filled with friends of promoters. Audited accounts conceal more than they reveal. Information can leak into the markets even before price-sensitive events happen. Cosy deals may be struck on debt, takeovers and restructuring that are not always in the interest of shareholders. Advisers may push products without taking any responsibility for their performance. Many players do not adhere to rules, processes or ethics. Investing requires careful navigation of these landmines, so do not trust too much, too soon.


Do not shirk the responsibility for your investment decisions and hope that someone else will deliver your long-term wealth. Take all the time to plan and allocate your money to good quality choices in a diversified portfolio. This approach almost never goes out of fashion.

 

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