In investing, the apt equivalent is: Be fearful when others are greedy, and greedy when others are fearful.
Yes, yet again, a Warren Buffett quote. If you imbibe it into your decision-making process, the chance of long-term success is probably maximized.
Regular readers of Contramoney have probably already got the drift. The time to buy Chinese stocks was when no one was buying, i.e. before the good news of the People’s Bank of China’s (PBOC) unusual actions to lift the economy and stock markets filtered through.
Unfortunately, interest in Chinese stock markets surged only after the good news. The Chinese markets surged like there was no tomorrow. According to Bloomberg, within days, the MSCI China Index surged 30% from recent lows.
Several people we spoke to were only now starting to figure out how to put some money to work in that market.
The ship has sailed
Not surprisingly, by the time the money actually gets to work, contrarian investors and fast movers would have made easy money. Perhaps this is already in the past.
I suspect for many, this will turn out to be a mixed experience at best. At worst, it will be a disappointing one. I hasten to add that in the short term anything can happen. So, I place zero weight on my own short-term “mixed experience” claim!
Having said that, this whole event has exposed, rather totally exposed, the investor. It leads me to conclude that the real crisis, which this column has alluded to several times in the past, is not that investors don’t know what to do. It’s they have no plan to begin with. Yes, I am referring to a well-structured, long-term asset allocation plan to meet your needs.
An absence of the plan sets no boundaries for the investor, who, as a result, keeps chasing one opportunity after another. Unfortunately, based on hindsight, the net result is often disappointing. Exhibit No. 1: A recently launched defence index fund that drew widespread interest from investors. The fund is down about 15% since the launch in July. The markets, by the way, are in positive territory.
Now, why would someone invest in a defence fund as part of a long-term investment plan? Unfortunately, many do. Even though, in most cases, it makes almost zero sense.
Let’s now go back to the Chinese stocks.
Ideally, investing in stocks, indices, or even mutual funds should not be constrained by geographical boundaries. You should invest only when you have a deep understanding of where the opportunity is (and, of course, in sync with your asset allocation plan). Naturally, given that most people don’t really know what’s happening in international markets, they stick to India. Again, that’s perfectly fine.
Here’s where things get interesting.
If you don’t understand international markets and yet invest, you are putting your hard-earned money at a lot of unnecessary risk. Why do that?
You could then say, I would take exposure via a mutual fund or an index fund. That’s fair enough.
But there’s a catch.
How do you decide which fund? You deciding to buy a China fund implies you understand the Chinese markets, and how it’s going to do over the long term. That’s a big call to make.
It’s akin to investing in India and focusing exclusively on the superhot defence sector.
Instead of “limiting” the fund manager to a sector or a country, why not give them the flexibility to invest across the world? Think flexicap or focused type of funds that have wide mandates.
Sure, such an approach could lead to a situation where you don’t make the most of a sudden surge in a particular market. But then, at the same time, you will also miss the other side of such bets, i.e. when they don’t work out. In effect, over time, you will potentially still do very well, but without the unnecessary drama.
You see, what works best is buying well-managed companies with a high margin of safety and then holding them over the long term. Buffett has drilled this into us. You can do this on your own if you have the skill or via fund/s.
Yet we stray. We end up chasing the next big opportunity, whether we understand it or not. Whether it fits into our asset allocation plan or not. And worse, we approach it in a way that limits our chances of doing well over the long term.
Perhaps Chinese stocks are one such misguided opportunity. Only time will tell.
Basics of investing
In conclusion, I wish to reiterate what I have learnt about avoiding such mistakes. Perhaps these could be of use to you.
First, be sure to have an asset allocation plan. The goal should be optimizing returns to meet your needs and not unnecessarily chasing ideas for maximum possible returns. This will help you ignore most of the investment noise around you.
Second, stick to what you know. Either you know how to pick stocks the right way, or you don’t. If you don’t, stick to well-managed well-diversified mutual funds. In general, do not limit your fund manager/management team to one segment of the market.
Third, as part of your allocation, have exposure to rental property, gold and even international markets. Each of these serves a purpose. If you don’t see the purpose today, visualise times of crisis (which happen often, by the way) and you will see what I mean.
Fourth, keep sufficient emergency money. This helps minimize the chances of having to make forced decisions, which generally cause a lot of damage to the process of wealth creation.
Fifth, and finally, don’t mindlessly follow the herd when it comes to investment ideas and themes. One fitting example here is the mindless infatuation with systematic investment plans (SIPs). And there are many more. Perhaps in the coming days and weeks, we will touch upon them in future issues of Contramoney.
This list is, of course, not exhaustive, but perhaps, sufficient enough to make you pause before you rush to tap into a new opportunity. Maybe investing in Chinese stocks fits into your plans, but then it would be because of so many other reasons. None of them, however, would be that the Chinese stock markets are rallying hard and that’s why you must invest.
Happy asset-allocating!
Rahul Goel is a finance and publishing professional with over 25 years of experience in the industry. You can tweet him @rahulgoel477.
You should always consult your investment advisor/wealth manager before making any decisions.