Monday, September 29, 2008

Live through Volatility

The newspaper headlines today were quite predictable, one screamed

"Halal Street ", and the other said “Trillion Rupee Crash” and so on after the mayhem on the stock markets yesterday.

Many investors are shaken up, and, obviously the 'first time' investors i.e. the recent converts to equity are wondering whether it was a wise thing to 'ditch' RBI Bonds, Post Office, Bank FDs' & PPF at all?  Should they revert to the old asset allocation plan of being in 'safe fixed income investments' and not take any risks at all?

Is all that 'glitters still gold?" i.e. is the 'good old gold' better than stocks & equity funds?

There will be endless analysis about 'FII taxation', 'rise in US interest rates', 'oil prices', ' fall in world equity markets' , inflation and so on. 

I can bet that there will be discussions about who was the big seller, which FIIs sold etc. 

So what does a sincere long term buy & hold investor do?

All the above-mentioned analysis & discussions about FII taxation, interest rates etc, are of academic interest to a genuine long term buying & hold investor.

I thought the best thing to do was check my own SIP investment, see the return of my own equity MF portfolio, whether it had survived the earth-quake of this magnitude on the bourses?

After all the proof of the pudding is in eating it.

So after saying my prayers twice this morning, taking a deep breath, gathering courage- I hesitantly punched the 'pale looking Navs’ of 18th May 2006, into the spreadsheet.

In the microseconds that the spreadsheet was calculating, I said my prayers once again and then slowly opened my eyes.

I looked at the XIRR of my diversified fund SIP that I have been doing over the past 4 years. The figure stood at a 'low of 52%'.  It stood reduced to 52% from app. 59% the day before! 

I looked at the spreadsheet in disbelief to see my portfolio return at 52% XIRR after the greatest market crash in history. Was my PC playing tricks with me?

I hope not I thought, so I punched the keys frantically & fed the 'pale looking NAV' again.... it gave the same number, 52% XIRR.

I looked around with a smile on my face, but immediately became serious when I saw the others in a sombre mood. 

I called my wife and whispered into the phone, "We are still above the poverty line”! 

Although the above piece has been written with a touch of humor, there are some serious inferences from it:

* A buy & hold strategy for equity investments is the only logical method of investing as validated by experts like Warren Buffet, Jack Bogle, and many others like them for decades. 

* As repeatedly warned by Jack Bogle, a short-term investor / trader follows 'rent-a-stock' strategy as opposed to the 'own-a-stock’ method of a genuine long term buy & hold investor.

Therefore when one does 'rent-a-stock’, you have to be prepared for events like May 18th and bear those consequences.

For the 'own-a-stock' guy there is no worry because he is by default part owner in a business enterprise as represented by that stock and therefore aware that volatility is a part and parcel of the process of creating wealth in the long term.

If one owned a business like say a manufacturing unit or a shop, that business would have both good & bad days and time periods during its long existence.

One wouldn’t normally sell a factory or the shop during a bad time; one would just stay 'invested' and continue with the business.

* Equity investments are for long-term goals; therefore the holding period has to be genuinely long term i.e. at least 5 years or more.  And this long-term wealth creation process is going to be accompanied by intermittent volatility.

Take it or leave it. Period!   There is no free lunch in life and you cannot have your cake and eat it too.

* If one does not have the expertise of direct equity investments.... as many don’t, it is better to invest via broadly diversified equity mutual funds, invest systematically, and stay invested till one's long term goals or objectives are met.

A lump sum investor also creates wealth if the time period is sufficient to iron out intermediate volatility.

* I have given the example of my portfolio just as an illustration of a 'buy and hold investor' surviving the stock market slaughter, investors should follow their own asset allocation plan, financial objectives / goals, time period of investment, and assess their own risk profile.

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