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Are you emotional? You could lose money

May 25, 2009 10:56 IST

The upper circuits of Golden Monday took every possible participant in the Indian equity markets by surprise. Though there was not much of buying on the day, Tuesday witnessed record volumes in the equity markets.

Later, though the volumes have been high, profit-booking has been witnessed in large-cap stocks, whereas mid-cap and small-cap stocks, which did not participate in the Golden Monday rally, have been rallying since Wednesday.

Suddenly the most pessimistic of foreign institutional investors and professional Indian and global bears have turned bullish, and are talking of a paradigm shift in the equity market landscape.

Expectedly, a lot of high networth individuals and retail investors who were not keen participants at market levels of 8,000 are feeling left out. People who thought they would enter at 6,000 levels are looking to enter now.

One hedge fund manager claimed, "We were 40 per cent long on India and now we will be 60 per cent long." Another fund manager boasted of India attracting huge foreign inflows.

Golden Monday was a rare event but what surprises me most is the confidence people have today to enter the market than when these were down to 8,000 levels.

Question yourself: "What has changed in the past several weeks?" Nothing major has changed and the macro numbers continue to be poor. What has changed overnight is the perception that the newly elected government, without Left support, will be able to usher in reforms. Will this now mean that all the problems we talked about a few months before have vanished?

Well, there could be major reforms down the way, but that does not mean we are out of the woods. What has changed now is sentiment and it will not take time for sentiment to reverse if reform expectations are not met or if there are any major global market reversals.

This brings me to the cardinal principle of equity investments: Invest when the markets are really bad and have a time horizon of at least 5-10 years and more.

Equity markets are ideal places to make money in the long run, provided it is put in appropriate investments. At the same time, they can be destroyers of wealth in the short run, as many would have experienced by now.

Most people, however, only think of equity when the going is good and tend to ditch it during tough times. However, just as relationship building pays in real life, so do sticking around and building the portfolio when the markets deliver stellar returns and when they don't.

Instead of looking at 8,000-9,000 levels as a wonderful opportunity to buy, investors who were super-confident of markets at 20,000 levels suddenly developed cold feet when the markets tanked.

The logic is I will jump in when the market bounces back. But the market is in no mood to tell anyone when the reversal will actually happen.

Hanging on to your good portfolio, weeding out bad investments and in fact buying more when the markets are suffering may sound stupid when lots of sophisticated investors are packing off and gurus were sounding off bearish tones. But these are precisely the times to make the best returns.

The markets could take a few years to recover and there might not be anything to write home about in your equity portfolio, but the cheap prices you will pay for good equity investments will compound tremendously in 10,15 and 20 years.

One should certainly review one's asset allocation and every investment regularly. However, there is no point in checking the prices every day and then worrying about them. Investors who resisted the urge to sell back in 1992, 2000, 2004, 2006 and now 2008 have made stellar returns.

The cardinal rule to be learnt from what we have witnessed recently and from several seasoned investors who have made money in equity markets is that 'Emotions should not drive or should not be your investment strategy.'

In fact a written financial plan that brings out the following points can be your best friend and guide during such times:

~ What are my financial goals ? Am I putting in short-term or long-term money in equities?

~ When should I buy? What should be my strategy to buy?

~ When should I sell?

~ What should I buy?

~ What will I do if the markets fell by 50 per cent? Do I really understand myself?

And, finally ask yourself: How can I protect myself from my biggest financial enemy, my emotions?

The writer is director, My Financial Advisor.

Amar Pandit in Mumbai