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How your emotions can cost you MONEY
Ashutosh Wakhare
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June 06, 2007

What happens when the stock markets fall? Most retail investors -- these are people who invest small portions of their money (less than Rs 50,000) at regular intervals instead of putting all their money in the stock market at one go -- lose money. This happens because the value of the shares you own reduces.

So, what happens when the stock markets rise? The retail investor (which is what most of us are) makes money, right? Wrong! We still lose money because we tend to, again, buy shares instead of selling them when the market rises.

Here's what you need to understand if you want to buck this trend and actually make money.

Retail investors tend to make huge losses primarily because they think they can easily make money in the stock market.

Herein lies the biggest problem. They just don't want to learn from their mistakes. The losses they make are blamed on someone else -- their advisor is not good, s/ he makes them buy and sell shares/ mutual fund schemes very frequently; markets are nothing but speculation, and so on.

Take a look at the following graph and you will understand the mistakes retail investors and, sometimes, mutual funds make. The data used in the graph is taken from the Association of Mutual Funds in India (AMFI) and the National Stock Exchange (NSE) websites; both of them carry detailed information on mutual funds and the stock market respectively.

The chart shows net outflows from mutual funds (growth schemes). Growth schemes are those in which people expect the money they have invested to increase faster as compared to other schemes. The outflow is caused when mutual fund investors sell their units and get cash in return.

The tall green line in May indicates that the mutual fund industry saw huge outflows of over Rs 10,500 crore in June 2006, post the (May)hem. In May 2006, the Indian stock markets crashed by more than 3,000 points from a high of 12,672; ordinary investors lost the most because they had bought the stocks at very high prices.

The crash-scared investors, many of them sold their shares and took back whatever was remaining of their investments. As a result, most of the stocks were available at throwaway prices. This was the time a savvy investor would have entered the market and bought shares. They would have made good returns on their investments by 2007 (the markets recovered from those lows and are currently trading at 14,000 plus levels).

Unfortunately, this is where the good part of the story ends. In the next three months -- that is, July 2006-September 2006 -- mutual funds saw redemptions (investors sold their units) to the tune of Rs 2,150 crore. The industry then saw an inflow (investors bought mutual fund units) of Rs 9,000 crore from October 2006 till January 2007.

In an ideal scenario, this is what should have happened:

Since the markets were falling from July 2006-September 2006, people should have invested their money and bought more units. What really happened was that units were sold. From October 2006 till January 2007, when the markets were rising, people were buying units. When what they should have been doing is selling them.

If retail investors had bought when the markets were falling and sold when they were rising they would have made profits. But they did exactly the opposite.

The story does not end here. Take a look at another chart and you will see the bigger picture.

It shows that mutual funds did exactly what the ordinary investors did. 

In June and July 2006 -- they were net sellers to the tune of Rs 2,058 crore (when they should have actually bought shares. Many experts, however, believe this is an aberration; mutual funds have been on the mark except for this period -- considered as some of the best months for buying in the financial year 2007).

In contrast, see what the foreign institutional investors did. They started buying from June-November 2006. The only consolation is that even the FIIs were not big buyers when the Nifty was at its lowest! 

This shows that FIIs were smarter than the mutual funds. What they did was what everybody should have done -- bought when the markets were down. FIIs did this, albeit to a small extent, because nobody knew for sure in which direction the markets would go; by simple logic and by historical evidence investors should invest when markets go down and vice versa.

It's the same everywhere�

The US, the birthplace of the mutual fund industry, leads by example. The recent 47th Fact Book edition (a report published in the US that presents the review of trends and activity in the US financial markets including mutual funds) has a variety of data published by the mutual fund industry. Here, I am presenting data for the 'Smart Indian Investor':

~ 73 per cent individual investors turn to brokers or financial advisers for help with choosing funds.

~ The way money flows in and out of funds shows that people invest when markets are doing well and exit when they are doing badly. Investors added over $309 billion to equity funds when prices soared in 2000 and pulled out $27.6 billion in 2002, when prices collapsed after the tech bubble burst.

So why are the retail investors losing the game?

I am sure no sane investor wants to lose. Then why is such plain logic so difficult to implement? The answer lies in your emotions. Whenever you are too euphoric or too tense, there is a 'chemical locha' in your system which makes you take decisions that are not based on logic!

Most retail investors are guilty of one common crime. Thhey sell when they should buy in the market and vice versa. Their patience thins out as they see the stock markets tumbling every single day (as it happened in May 2006) and join the herd in selling stocks purchased at higher prices.

It is this herd mentality that separates the winners from the rest. If you succumb to it, then you lose. If you brave the wild volatility in the market and stay put, you win.

And here's the solution

Nobody knew about the May 2006 crash before it happened. Nobody knows where markets will close today. Nobody knows whether the Sensex will close above 14K or below that level in 2007. So why not just take a SIP and relax?

We have some excellent fund managers, the regulator (Securities and Exchange Board of India) is doing everything to protect the interests of the small investor, and so what's the problem with the investor herself/ himself? Why not just invest a small amount every month and let the investments run on autopilot?

Can anyone of you explain what logic prompted the selling of mutual fund units in July 2006-September 2006? The only reason I would have sold during this time is if I was convinced that India's growth story was over. But that was not the case, so why sell?

Had you invested wisely in SIPs, you would have benefited in 2006. It was these very months that brought average cost of your units down (had you bought during this period). But some investors choose to learn the hard way; sadly, many are yet to learn this simple mantra.

The author runs a Nagpur-based finance advisory Money Bee Investments. He can be reached at moneybee.finplan@gmail.com.


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