“One of my friends suggested that I invest in Asian Paints now since the market expectation is that it is likely to announce good results, and historically it has done so well. However, he told me that if I have to make money in the stock market, I should be invested for the long-term”
Two part series – 4 Key Investment Questions
Such conversations can sound very familiar and we may even act on the advice since it sounds very logical. But here are the problems with that statement:
- There is an advice to time our investment (market timing)
- There is an advice to invest in a stock because it has done well in the past (past performance)
- There is an advice from a friend, who may or may not be an investment advisor or specialist.
- There is an advice to invest for long-term without defining what is long-term, and finally
Should we wait for good time to invest in market?
There is no good or bad time to invest, just like there is no good or bad time to look for a job! Even if there is one, it is known only after the fact and hence it is useless. Let us flip this question and ask “How can I time the market correctly?” This question, in other words, means that we should be smart enough to buy at the bottom and sell at the top and therefore make money. However, the bottom or the top is evident only, after the fact and not before. For e.g., if you look at a historical chart, you can know what is bottom or top, but if you are asked to draw a graph into the future clearly identifying the bottom and top, I am sure only 0% of the people can do it. If you have to get the market timing right, you should be right two times (predicting the top and predicting the bottom). You should be right two times, every time you make an investment call. Nearly impossible, from a probability point of view. Hence, the best answer is there is no good or bad time to invest in the market. So long as you have a consistent investment habit, over a period, timing will be irrelevant. As they rightly said, “time in the market” is more important than “market timing”.
Market timing will hurt you if you have sporadic investment habits as you may be caught in a bad cycle and will have to wait forever to recover your losses. Alternatively, you may be lucky enough to have a great start and can see through several bad years since the start was good. For e.g., if you invested at the beginning of 2008 in the Indian market, your investment value would be down by 52% at the end of 2008 and you will be still licking your wounds till 2013 which is when you would have broken even. On the other hand, if you invested at the beginning of 2009, your investment value would be up by 76% at the end of 2009 itself, and another 44% in 2010 and you will be laughing your way until now. Nevertheless, both outcomes are unpredictable and is purely a factor of luck. Hence, the idea of timing the market is a bad one. Instead, one should have a consistent way of investing in the market.
Should we invest based on past performance?
The now familiar mutual fund disclaimer “past performance does not guarantee future returns” played in double-quick speed in television ads is really a good disclaimer to focus on. However, in the absence of another alternative, the question becomes, “what else to look at?”
Whether, we want to invest in a mutual fund or individual stocks, we always get obsessed with how they have done. Here again, there are two problems. One pertains to doing well and the other pertains to doing well consistently. The second aspect is more important than the first aspect. It is possible that a mutual fund or a stock can perform better than others can, but they cannot do it consistently year after year. In other words, they may be winners today with no guarantee that they will be winners tomorrow. The challenge for us is to identify tomorrow’s winners not yesterday’s winners. Many investors base their investment decision on fund ratings (remember the Morningstar or Value Research stars ratings from 5 star to 1 star). However, research has shown that 5-star funds need not do well going forward nor 1-star funds need to do badly.
The issue of examining past performance is again linked to market timing and hence can be an ineffective tool for investment decision. Again, a consistent investment plan will obviate the need to depend mainly on past performance.
The second part of the 4 key Investment Questions Series – Long Term & Who to approach?
Mandagolathur Raghu is the head of research at Kuwait Financial Center (Markaz), a leading asset management company based in Kuwait with AUM exceeding $3billion ...
