But I do what is in accordance with my personality and risk appetite. I also said that his comment of ‘markets are supposed to rise’ was not sensible as markets are not controlled by anyone and cannot be predicted. And that for a real long term investor, it doesn’t make much sense to time the markets.
The idea of making money overnight is what brings most people to stock markets. However, its easier said than done. Making money in markets is not easy. No matter what anybody (me included) tells you, it is not easy. But it is also not impossible if you have the common sense to understand one simple concept.
I know the title of this post sounds spam-like. But its not, I swear. 🙂
Now stock market is a volatile place. If you have been in markets for last few years, then you will agree with me on this. And if you are new in market, then you will agree with me pretty soon. 🙂
Many people believe that just because they can easily calculate CAGRs using excel calculators, markets will respect their efforts and only move up or down in straight lines. But I am sorry to disappoint. This notion is as wrong as the idea of Sun rising in West. Markets never go up or down in straight lines. Never.
So then why are stock markets volatile?
Why is it that many times, markets suddenly fall by 5% or maybe 10%?
Think of it like this…
All companies exist to make money for their owners (investors). So a company needs to make money to exist. But nobody actually knows how much money a company can make in future. And all those who claim to know are only referring to their opinions and projections about it. Now everyday, on basis of these opinions and projections, lacs of people buy and sell stocks of these companies. Those buying feel that they have got a good deal and those selling feel that they have got a good deal. But in real world, both cannot be right simultaneously. 🙂
This constant buying and selling is what makes the market do up and down… When either of two (buying/selling) increases many times of other, markets either crash or go through the roof. This is what makes markets volatile.
This volatility is exactly what makes market, an ideal place to make truckloads of money. But only if you have the patience to wait and the courage to invest when things are worth investing.
You may ask…
When are markets worth investing?
The answer, atleast for long term investors is that when markets are cheap.
You might feel that it is quite easy then. After all, there are many indicators that tell when markets are overvalued or undervalued. Isn’t it?
True. But as Buffett famously said, Investing is simple, but not easy.
So the right question to ask here is…
When are markets reallyworth investing?
The answer is, when markets are cheap, even by low IQ (no-brainer) standards.
Ofcourse, you won’t get such opportunities regularly. May be you will get such chances only 3 or 4 times in your life. But that is what real successful investing is all about.
Talking of volatility reminds me of an interview held in India, where Warren Buffett said:
If you look at the typical stock on the New York Stock Exchange, its high perhaps, for the last 12 months will be 150% of its low. So they’re bobbing all over the place. All you have to do is sit there and wait until something is really attractive that you understand.
Now this quote made me curious.
I know that individual stocks do ‘bob around’ a lot and can be quite volatile. But even if we were to consider broader markets, it can be quite volatile within short periods like 1 year.
This short-term volatility offers tremendous opportunities to investors to build long-term positions, even at broader market levels.
Now I tried to evaluate Indian markets from the lens of Buffett’s High/Low wisdom. Also, instead of choosing individual stocks and complicating this analysis, I picked our bellwether index Sensex, whose data was easily available here.
And this is what I found…
Buffett is right. Even for Indian markets. As you can see, even indices are volatile in line with his statement. Though high/low volatility seems to have decreased since 2010, stock markets are still volatile enough for us to contemplate about it with all seriousness.
Volatility is not just important for long term investors. Even short-term traders understand its importance and make a career (and at times, fortune) out of it!
Have a look at the High/Low gaps in table above. Its clear that markets give numerous opportunities, even on an annual basis. You just need to have the patience to wait for the right opportunity. You can use market’s volatility as your friend.
John Huber of Saber Capital Management (Base Hit Investing) says,
There is no logical way to explain why large, mature businesses can fluctuate in value by 50% on average in any given year. It makes no sense that the intrinsic values of large mature businesses can change by tens of billions of dollars in a matter of months—and this dramatic price fluctuation occurs on a regular basis—in fact, every year.
Lets take an example of the year 2014. The high and low for Sensex in that year were 28,822 and 19,963 respectively. So that means that yearly-high of Sensex was 44% higher than its yearly-low.
This begs the question:
Are the 30 largest Indian businesses really 44% more valuable than they were just few months earlier?
Though in hindsight, its obvious that due to the euphoria around installation of new government at centre, government’s underestimation of economic problems and people’s overestimation of new government’s ability to solve those problems, market behaved in such an irresponsible (!) manner.
But this is how markets function – they first overestimate and then underestimate.
Pick data for any year and trend remains same. And so does our question:
Are the 30 largest Indian businesses really XX% more valuable than they were just few months earlier/later?
Answer this time too, remains same – Unlikely.
And mind you, we are talking about (averages of) 30 largest Indian companies and not even small companies having comparatively unpredictable businesses. If we were to choose smaller companies, my guess is that their values will fluctuate even more.
Again quoting John Huber here, greater volatility brings greater opportunity for investors as the more a stock fluctuates around its true value, the larger the potential gaps are between price and intrinsic value.
Obviously this list [above] tells us nothing about the intrinsic value —only that the prices fluctuate widely. But it should be fairly obvious that prices are fluctuating much more than intrinsic values—which provides us with opportunity.
So be sure of this – markets are volatile and will remain so. This is the nature of market. It will not change. And understanding the nature of market is the key to have the confidence that you are not doing anything stupid. This confidence will allow you to invest large amounts when markets are down and others are selling out. This is when you will make some real money.
Talking of building confidence, I leave you with words of a financial blogger Pete (of MMM) that exactly voices my thoughts about stock markets:
It’s worth gaining this confidence, because investing knowledgeably in stocks has always been the single best thing to do with your money in terms of getting lifetime income with absolutely no effort on your part.
Where else can you hire people to work for you and you own their companies.
So embrace volatility and make money in stock markets.
A few days back on a flight to my hometown, I was reading a book on Warren Buffett – Tap Dancing To Work. The person sitting next to me got interested and asked me whether the old man on cover was the well known investor Buffett. This question was the start of our small but interesting conversation about stock markets in general and my investment philosophy in particular.
Now this person was far more talkative than a few which I know of. And hence for 90% of the 2 hour flight, I ended up listening to him. 🙂
It became quite clear that he had burned his fingers (& money) in 2000 and again in 2008 Crisis. He also seemed to be having a tough time believing in market’s potential to make people rich. Anyways…he told me about a lot of stocks which I had not heard of. And unsurprisingly enough, these stocks had brought down his portfolio substantially in past.
But the interesting part came when he asked me about what I was buying in current markets, which are regularly making new life-time highs. I told him that apart from few stocks which I purchase regularly (almost irrespective of prices & for really long term), I am not buying anything.
He was surprised as he thought that since everybody else is buying…and if I considered myself to be an expert investor (since I was reading a book on Warren Buffett – ;p ), I should also be buying stocks and finding potential multibaggers.
I told him that I am not looking at finding the next multibagger and am pretty satisfied with my mutual fund SIPs and few stocks which I am accumulating in my core portfolio. He unsurprisingly was not impressed with my reply.
Then he asked me what I did in 2008-2009 when markets crashed. And whether I was able to get out of markets in time? I told him that since I had just started earning during those years and still did not have significant sums in markets, I never cared about getting out of markets at that time. I was rather more concerned about getting in when share prices were falling like anything and there were plenty of no-brainer deals available if one looked carefully.
This ticked him off somewhere deep. He said that:
“This is not how an investor operates. You should be able to get out before a market starts to fall. And start buying when markets are ‘supposed’ to rise for next few years. You seem to have double standards in stock markets….you try to buy when no one is buying and try not to buy when everyone else is buying.”
I told him clearly that I don’t know what a typical investor, or for that matter an expert investor should do or shouldn’t do.
If others are comfortable buying in rising markets then so be it. I am not and I will not go with the trend.
There was nothing noteworthy in rest of our conversation as this person realized that I could not be convinced and I realized that its not easy to convince someone about the benefits of long term investing when that ‘someone’ has lost a lot of money in markets.
Thankfully for me, pilot’s announcement of approaching destination came as a way out of the discussion, where for the first time I was accused of having double standards and I happily accepted it. 🙂