In early 2000, a business newspaper carried a front-page picture of a big crowd in front of a bank. The picture carried the headline, “ Investors queuing up to apply for shares of an unknown software company.” A year later, many software companies went defunct.
In 2003, I told an acquaintance to invest a small amount in mutual funds. I met him in 2007. He hadn’t yet done. Instead that year, 2007, he found courage to buy into two IPOs.
Ofcourse he didn't seek my advice. Needless to say, now in 2013, those two stocks are bleeding. It is estimated that a third of Indian investors have bought only those two stocks and are now staring at a large loss!
How did this come to pass?
How come people who refuse to invest, suddenly find the courage to buy any garbage that their brothers-in-law ask them to buy? The fault, as usual lies, with us. We don’t follow basic rules. The comparisons we do, the questions we ask when we buy mobiles and tablets are never done while investing in stocks. Sad, but true.
Here are five thumb rules that we can use:
1. Putting all of your eggs in different baskets
Whenever I travel my father always tells me to keep some cash and a debit card separately from the wallet. The idea is that in case the wallet is lost, I would not be stranded for cash. The idea is the same as not keeping all your eggs in one basket. Invest in house property, equity stocks, mutual funds, gold,...
At the height of the real estate boom of USA in 2008, a NRI told me that her servant maid owned 4 houses (all bought on zero down payment loans, of course) and finally had to sell all of them and still owes the bank money. Diversification is about sleeping well. Remember the best laid plans of mice and men can go awry.
2. Falling for high returns and low risk trap
Whenever you hear someone saying 24 per cent returns with no risk,” run as if a lion is chasing you down. Promise of high returns whatever may the business model, be, reeks of a Ponzi scheme. Any business that promises high returns especially within a short span is taboo.
3. Not investing regularly
We all understand in Fixed Deposits and invest heavily invest in these or in real estate. But most of us never look at investing regularly in equity markets via monthly investments called Systematic Investment Plan( SIP). Indian investors invest little in their own equity markets but today foreign investors hold a large stake in many of our banks and our manufacturing companies... The foreigners seem to have more faith in our country’s future than us!
4. Check valuations not the price
While investing, valuation matters a lot. For equity shares the most widely used valuation metric is reflected in the PE ratio. The higher the ratio, the costlier is the valuation. This does not necessarily mean cheaper stocks are good. I have seen many people go only by price and not valuation. So if ABC stock is trading at Rs 1000 they assume it is costly and XYZ is cheap because it is only Rs 10. What matters is price compared to profits. Thus if ABC price has a profit per share (EPS) of Rs 100, its PE is 1000/100 or 10. This is generally considered worth investigating further. On the other hand, if XYZ’s earning per share is Rs 0.5 its P/E will be 10/0.5 or 20. It is twice as expensive as ABC. So thinking Rs 1000 is costlier or Rs 10 is cheap is simply not right.
5. Falling for the new-new thing
Dot com in 2000, infrastructure stocks or funds in 2007, gold in 2012 or may be real estate in 2013. Buying into anything that is extremely fancied by most is a recipe for at best very low returns or at worst disaster.