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Thursday, June 20, 2013

Sensex falls 500 points – time to buy or time to run?

To succeed in the stock market, one needs to think and act differently from the herd. Most small investors enter the market with very little knowledge about how the stock market functions, which sectors perform consistently, which sectors are cyclical in performance, and which sectors are perennial laggards.

A motley collection of stocks are acquired based on well-meaning advice from friends or colleagues, and not-so-well-meaning tips from web sites and SMS marketers. When many of these stocks start to fall in price soon after buying, more quantities are purchased in a desperate hope that ‘averaging’ will some how retrieve the situation. End result is loss of capital.

Such a pattern of behaviour gets repeated again and again, and is one of the main reasons why small investors rarely make money from stocks. Some learn from their mistakes by spending the time and effort to read investment books written by well-known stock market ‘guru’s. Most give up stock investing all together.

How does one think and act differently from the herd? Step one is to do some basic preparation before entering the market. Visit web sites like investopedia.com. Read books by Peter Lynch, Jeremy Siegel, Martin Pring to get an idea about how to invest for better returns.

Step two is to make a financial plan, based on one’s likely income and expenditure. Without a plan, goals can’t be set; without goals, not much can get achieved. Goals should be specific and realistic - ‘x’ amount of money for buying a car/bike in 2 years; ‘y’ amount for children’s education in 15 years; ‘z’ amount for a holiday every 3 years.

Step three is to make an ‘asset allocation’ plan. Such as, 40% of savings to be invested in fixed income instruments (like bank FD, PO MIS, NSC); 50% of savings to be invested in stocks; 5% in gold; 5% in cash for exigencies. The percentages can be tweaked according to one’s age and risk tolerance.

Only when you have completed the three steps should you start to buy stocks. What if you don’t have enough money yet to buy stocks? Build up your capital by regularly investing in a bank recurring deposit or a good balanced fund. It may take 3 years or 5 years before you accumulate sufficient capital to invest according to your asset allocation plan.

So be it. What is the rush? Rome wasn’t built in a day. A strong investment portfolio that can generate wealth takes years and years of effort of disciplined investing and monitoring. It is not rocket science. Neither is it sexy or exciting.

John Templeton had famously said: The best time to invest is when you have the money. If you are diligent about saving and investing according to your plan, you will always have some money available for taking advantage of sudden opportunities – like the one provided by a sudden drop in the Sensex for no apparent reason.

It takes courage to buy, when every one else seems to be selling and running. Easier said than done. But being a contrarian and acting differently (not foolishly) is the key to investment success.

That was the long answer. The short answer is: Your asset allocation plan should dictate what you should do.

Related post

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How to reallocate your assets

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