Thursday, March 25, 2010

Do you invest with your head, or do you invest with your heart?

One of the building blocks - may be the most important one - of becoming a successful investor is to know yourself. To help you understand if you invest with your head or your heart, here are some practical situations that you are likely to face:-

1. March is usually the time for last-minute tax-saving investments. So you start looking at some ELSS funds. You hold the SBI Magnum Tax Gain fund since Mar '07. It was one of the best ELSS funds then and gave good dividends.

Your head tells you to sell it because of its recent under-performance and switch to Canara Robeco Tax Saver or DSPBR Tax Saver. Your heart urges you to stick with it as it will surely return to its earlier glory.

2. The Nifty is trading just short of its Jan '10 high for the past 6 trading sessions. Your head is saying 'be careful' because a previous top made some time ago can be a tough hurdle to cross. Your heart is saying 'a new high is imminent' and this is the time to jump in.

3. You had made a killing in the Bharti Airtel stock when you sold part of your holdings when it hit 1200 (pre-split) back in 2007. The rest of your holding effectively became 'free of cost'. Ever since, the stock has been sliding, but you held on because your holding cost was zero.

Your head is urging you to get rid of it, as the entire telecom services space has lost its pricing power with the entry of big global players. Your heart is forcing you to hold on because Bharti has proven management and the stock will definitely move above 500 soon.

4. Your decision to pick up OnMobile Global shares at 250 in Mar '09 turned out to be a really judicious move, as the stock zoomed to hit 700. Out of the blue, the bears attacked and the stock halved in value to 350.

Your head is accepting the fact that you got a lucky break initially, but you goofed by not booking profits at 700. Your heart is considering it as plain bad luck that your smart pick suddenly changed direction through no fault of yours.

5. You read my blog post about Indraprastha Gas back in July '09 when the stock was trading at 137. I had mentioned a possible target of 180. You decided to spend some time to research the stock thoroughly. But within a month, before you could gather sufficient details, the stock hit 180.

Your head told you to wait for better valuations. Your heart decided that you should buy before the stock runs away even higher.

6. Cranes Software was a hot stock in the previous bull market. It sold engineering software products to overseas clients and made huge profits. Because of the down turn, the stock hit the skids but at 45 it seemed like a screaming buy.

Your head warned you not to try and catch a falling knife. Your heart ignored the warning as the downside seemed very limited, and you bought a large chunk and then averaged down at 30.

If you are like most investors, you some times invest with your head and at other times invest with your heart. There are no guarantees which will be a better investor - your head or your heart. Logically, for long-term investors, the head should rule the heart. But stock markets can be illogical in the short-term.


scorpio said...

Great stuff :) Yes most of the times we go with our heart and we end up losing. Very true - its a game of the mind.

You have taught in your blog, being simple with things. check cash flow, few ratios, the technicals and then decide what to do. I most of the times get carried away and dont bother much even if the mind is telling me something else.

chandra said...

It is a very interesting article. It will be my constant effort to use head before going for a buy hence forth. I am new person to vist your blog and i cann't stop my self to say that I became your fan. as a lay man I wanted to understand what this cash flow is all about. It would be a great help for me if you could through some light on it in order to understand the stock fundmentals.
Here I would like to take the opportunity to say thank you for sending the ebook "How to become a better Investor". Its simply a fentastic book for dummies like me

Subhankar said...

@scorpio: Appreciate your comments. Identifying your investment mistakes and ensuring that you learn from them and don't repeat them is a step forward in becoming a better investor.

@chandra: Welcome to the blog and thanks for the kind words. Learn how to read the Cash Flow Statement in Annual Reports - the effort spent will be well worth it.

There are 3 parts to the Cash Flow statement - the first deals with cash generated from core business activites; the second deals with cash spent in investment activities - like plant and machinery, new offices, subsidiaries, etc.; the third deals with cash from financing activities - loans and share issues.

Negative cash flows from core business is a red flag.