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Tuesday, June 29, 2010

Strategies for buying and selling stocks and mutual funds – analysis of last week’s exercise (Part I)

Last week’s reader exercise was a prelude to introducing certain strategies that can enhance the returns from stock market and mutual funds investment – particularly when the market is in a prolonged sideways consolidation.

Before I get into the analysis part, a big THANK YOU to all of you who participated. Except for questions 2 and 4, the answers to the other questions varied widely – as should be expected from investors with different experience and risk tolerances.

The Sensex has been trading in a broad band of about 2700 points – between 15300 and 18000 for almost 10 months. During this period, individual stocks have either hit the skids, or made new highs, or gone nowhere. Should you try to jump from stock to stock as one slides and another climbs? That would make the brokers rich.

At such times, stock picking skills come to the fore. Identify good funds or fundamentally strong stocks that still leave a ‘Margin of Safety’ and buy a small quantity. Where will the cash come from? If you had booked profits earlier and not redeployed the cash, then you have no problems. What if you are fully invested?

This is one reason why I recommend quarterly dividend option in bank fixed deposits (FD) and dividend options in mutual funds. That goes against the tenet of growth through compounding. But an investing strategy has to be flexible to factor in market vagaries.

The cash inflow through dividends and interests has several advantages. In funds, it works as automatic profit booking during bull phases. The dividend can either be reinvested in the same fund, or in a different fund, or to buy shares.

The interest from a fixed deposit can be invested in a recurring deposit, or for buying NSC certificates from the Post Office (which are not subject to the fluctuations of bank interest rates), or for buying funds through the SIP method. The principal should get reinvested in another FD – for a shorter period if rates are low. (An exception to this ‘rule’ will be covered in Part II next week.)

Question your own logic at all times, and try to avoid the ‘always growth option’ or ‘always through SIP’ strategies of investing. Suppose the market corrects viciously down to 12500 in the next 2 months. Unlikely, but possible. A year of gains will disappear from the growth option. SIP over 2 months of lower NAVs will not lower the holding cost of the previous 10 months by much.

Regarding gold, this what Warren Buffet has said: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

I haven’t felt the need to buy gold. But if I did, it would probably be a gold ETF or a gold fund. Much more convenient from storage and transaction points of view.

This post has already become too long, and I haven’t even covered questions 4, 5 and 6. Guess you will have to wait till next week for my analysis – because 4 and 5 are a little tricky, and will need some explaining.

In the meantime, nods (and applause) for Rsuvarna, Joe and Ganesh for logical answers. A hat tip to Eswar for his elaborate thought processes which helped in writing this post.

Those whose names didn’t get mentioned, please don’t feel disheartened or slighted. None of the answers were ‘right’ or ‘wrong’. I was looking for the logic behind the choices.

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