One should not time the market before investing, says Ajit Narasimhan
Illustration: Uttam Ghosh/Rediff.com
There is surge in investment in the market by domestic as well as retail investors. Not surprisingly, the market has gone quite a bit up in the last few months and was almost close to its 17-month high this week.
The Indian economy looks promising and the stock market is bound to give satisfying returns in the months to come. However, the stock market is also a volatile ecosystem. It goes up dramatically and comes down heavily at times.
In the short term, there are bound to be huge fluctuations in the market. This is often misunderstood by investors to be peaks and troughs. Consequently, they try to time the market, i.e., decide to sell or buy at these 'peaks' or 'crests'.
Unfortunately, investing in the stock market is not such a simple affair; otherwise, all investors would have been billionaires by now. In this article, we take a closer look at the tendency of investors to time the market and discuss the pitfalls of doing so.
Why investors try to time the market
The stock market is full of rags-to-riches stories that make media headlines. However, rarely does the media report stories of loss and bankruptcy.
One of the reasons for this is that such stories do not make good news or attract readership. Usually, getting rich because someone entered at precisely the right time and came out at right time, too, is a matter of sheer luck and not because of their genius in spotting the trend of the market.
The second reason is investors’ experiences in the past. Sometimes, just by coincidence, investors enter the market at the right time and make money. This is often taken, incorrectly, as a personal skill in timing the market.
Why timing the market is a bad idea
Market, by its very nature, is volatile. Some stocks may be volatile in the short term while some may be so even for the long term. Volatility is one of the inherent characteristic of the market. This is what makes markets interesting and provide a patient investor opportunity to make money.
Additionally, there are too many variables affecting the market. Some of the events in the past that have affected the markets across the globe are the slowdown in US and EU markets, wars and unrest in the Middle East and the ensuing oil crisis, NPAs in banks, change in Governments and policies, and many more factors internal and external to the company.
In all these factors, there is high amount of uncertainty which makes it next to impossible to correctly predict these events or their impact on the market, and hence to time the market.
Moreover, consider this:
- What is the basis of timing the market?
- Should we take a market price/earnings ratio (PE) of 9 as the bottom or 12 as the bottom?
- Should we consider market PE of 20 as the peak or 30 as the peak?
- How do we factor the economic growth rate into the market levels?
These are important questions and any answer to these will be mostly subjective or speculative in nature. There was a time when a technology stock’s PE of 100 was considered normal while the same companies today are called expensive at a PE of 20.
What should investors focus on?
Investors should focus on good companies and avoid thinking of the market as a gambling den. Identify a few strong companies and invest a part of your investment. Finding good companies is not very difficult.
One place to start is to look at the Sensex or Nifty companies. BSE-100 could be another good set to select the right companies to invest in.
Once you invest, have patience to ride through the rough and tumble of the stock markets. As has been evident time and again, being patient is the difficult part.
At the same time, investors must realise that investing directly in stocks is risky unless they have some knowledge of companies and stock analysis. A better way to put money in the market can be to invest through mutual funds.
Mutual funds are run by fund managers who invest in a set of assets. The presence of different companies and assets in the portfolio of mutual fund makes it better prepared to handle the stock market’s fluctuation.
Moreover, mutual funds offer a plethora of choices and ease of investment. You can start a SIP in mutual funds, which will take care of market fluctuations.
Finally, avoid falling in the trap of agents asking you to invest in certain assets or companies to double your money in a short time. They have never worked in the past, nor will they in future.
Invest wisely, with doses of common sense moderating any investing arrogance.
Ajit Narasimhan is Category Head - Savings and Investments, BankBazaar.com