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Lessons for investors

September 10, 2003

When the markets boom, the regulator gets jittery. And not without reason. Recollections of recent market booms are tinged with memories of scams and subsequent JPC investigations -- from Harshad Mehta to Ketan Parekh.

So it comes as no surprise that Securities and Exchange Board of India and the stock exchanges are working overtime to appear pro-active.

The stock exchanges are pumping up margins and tightening the trading regime to thwart potential wrong-doers; and Sebi keeps issuing warnings to investors with metronomic regularity.

Without doubting Sebi's good intentions, it is difficult to avoid the feeling that these warnings are with one eye on the next JPC -- if it comes to that, and somewhat like putting statutory warnings on cigarette packs.

They must be there, but they make no difference to the determined smoker. Jesse Livermore, a famous US trader, once said that there are only two emotions in the market -- hope and fear. "The problem is, you hope when you should fear, and you fear when you should hope."

Since Sebi is no authority on market timing, its warnings are unlikely to have much effect. The only advice to give is to tell investors that equity markets involve risk at all times (and not only boom times). The issue is not whether one should invest now or later, but whether one is taking risks that one can handle.

So what are the lessons investors need to learn? Starting with Livermore's observation, every investor should be asking himself whether this is the time for hope or fear. Quite obviously, there can be no straight answers to that.

The markets could zoom past 5000 without batting an eyelid, or they could crash below 4000 without so much as a by-your-leave. It all depends on how events over the next few months shape perceptions of the future.

Moreover, a lot depends on which company or sector you put your money on. For small and amateur investors, the first lesson to learn is that there are no short-cuts to quick wealth. When even the best professionals make mistakes, they are more than likely to make mistakes, too.

This means they should only invest money that they can afford to make mistakes on. The second lesson is about market timing. Over reasonably long periods, investment in a broadly diversified portfolio or in index funds has outperformed other, safer asset classes.

Patience -- apart from sensible stock selection -- is the key to making money on the bourses. The third lesson is prudence and discipline.

This means regular evaluation of one's asset allocation. If an individual's ideal risk profile is 20:80 -- 20 per cent allocation to equity and the rest to debt or risk-free instruments -- one should not allow a stock market boom to convert this ratio to 40:60 suddenly.

This increases risk, at a time when the investor's risk profile may remain the same. It is these messages that Sebi must drill into investors rather than offer non-specific storm warnings.

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