AuthorRohit Chauhan

I received the following comment from Raj. I am posting my response via a post. Please feel free to share your comments

Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)

Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.

Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.

Debt instruments – my thoughts on the same here

Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.

I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.

Did I catch you on that ? are you expecting someone would be able to predict that for everyone ?

For the last one year, there has been an army of people trying to predict the end of the bear market. Most of the so called pundits were expecting the global recession to end by Q1’09. Now the predicitions have shifted to Q3’09 or towards the end of the year. The same pundits were predicting oil to touch 200 dollars a barrel. As the saying goes – If I had a penny everytime a bozo made a prediction, I would be rich !

I would suggest you to read N N taleb’s books – Fooled by randomness and The black swan which talks of this bias. All of us have this strong desire to predict and see patterns. It is a strong, innate human tendency which causes most of us to seek predicitions of the future and see patterns where none exist. The problem with markets is that there are often no such patterns and the future can rarely be predicted accurately for a long period of time. Yes, some so called gurus can get one predicition correct, but that does not mean that this person has some special ability to see the future.

If you predict often, you will be correct a few times too. There is considerable research into the accuracy and success rate of such predictions and most of the studies point to less than a 50% success rate. That is worse than a coin toss !!

How to invest without predicting the market ?
So how does one invest, if one cannot predict where the market will be in the future ? I think there is a big mis-understanding that one has to know where the market is going, to be a successful investor.

If you plan to invest in an option which will expire at a fixed time, then you will need to predict how the market will perform during the duration of the option. However if you are able to identify a good company with a sustainable competitive advantage, which is likely to do well over the next few years, then you are likely to get a good return on investment.

As the company does well, the underlying intrinsic value is bound to increase. When this happens, the gap between the price and the value will increase (assuming the price is stagnant ) and the stock will be get progressively more undervalued. In most of the cases (not necessarily all), this undervaluation will create an upward pressure on the stock price. In most of these cases, the gap closes suddenly and the returns are made quickly over a very short interval of time. It is however diffcult to predict when this will happen.

So what happens if the price takes longer to recover ? Well, if the intrsinc value is increasing, then you have an opportunity to increase your holding as the gap keeps getting larger and the returns should be better when the gap finally closes.

So why does’nt everyone do it ?
For one, it is painful to watch your stock stagnate over long periods of time. If you look at price to validate your decision, then a stagnant price only increases your self doubt and anxiety. Most investors are not wired to ignore the price and focus on the intrinsic value. That also explains why it is diffcult to practise value investing.

Where do we go from here ?
For starters, stop trying to figure when the bear market will turn. If your imvestments are based on the market turning soon, you could be in for a lot of dissapointment if that does not happen.

I personally watch CNBC, read the news and listen to all possible predicitions from all and sundry, but only for entertainment. Whenever some tries to give me an elaborate reason on when the market will turn or the recession will end, I have a single thought in mind – ‘How the hell do you know ?

What am I doing ?
I am reviewing my current holdings. The Q3 results have been announced for most of my holdings and I am in the process of analysing the same.

In addition I am focussing on learning about behavioral finance and biases. I would be updating my templates based on my learnings and would be re-analysing my holdings again. It is quite possible I may discover that I should exit some holding and some bias is holding me back. I will be posting such analysis when I come to such a conclusion.

Timing the market is a very enticing proposition. It is seductive to think that if one can find the tops and the bottoms of the market, then one can make supernormal returns. There are charting approaches, wave theories and a bunch of other stuff to predict the market. However most of the academic research on such ‘publicly’ known theories indicates that the returns after costs is lower than passive investing.

Note the word public. There maybe investors out there who have systems to predict the market and make a killing. Well, they are not going to disclose that anytime soon.

So for the common investor, we have the option to either use publicly known systems knowing that the academics may very well be correct and use it till we can prove them wrong. The other option is to develop your own systems, which yield excess returns.

The same argument can be applied to value investing. Academic say it is not possible as the market is efficient.

My own journey has been of a skeptic, to a tentative believer to a firm believer. I read about value investing almost 10-12 years back. It made a lot of sense, but I am not one to have blind faith. I was not ready to invest money in any approach till it worked for me. As a result I read books on value investing and on the efficient market hypothesis too. At the same time I started applying the principles with my own money, but on a very small scale. As my returns have outpaced the market, my confidence has grown to a point where this is the only approach for me and a majority of my funds are invested via this philosophy.

So value investing is not some religion to which I got converted one fine day. I started as a tentative believer and have got convinced as I saw my own results.

I wrote in my previous post about time management issues, we face as non-professional investors. We barely have enough time for our jobs and family. How the hell can I one pursue an outside interest such as investing ?

I am not referring to investing one’s capital via other vehicles such as mutual funds, FD etc. These options require much lesser time and can give a decent level of returns. I am referring to pursuing investing as an interest or hobby. In such a case, one is not looking for only returns, but also at learning and becoming a better investor.

The beginning
My own journey started more than a decade ago. I had started managing the finances for my family and had started reading up on the basic such as what is an FD, what is a stock etc. Those were pre-internet days, so access to information was limited. I remember searching for books and finding very limited numbers on investing. My main sources of learning initially were finance textbooks and economic times.

By 1998, I had access to internet and that was like opening a huge door for me. For professionals like us, the internet is god send opportunity. I cannot imagine being able to learn and develop as an investor while still working at my day job without the internet. Even this blog would not have existed without it !

Well, with access to internet and all this information, I started reading and learning the basics of investing. The period 1999-2002 was time spent on learning the basics. During the period 2002-2006, I started reading more annual reports compared to general articles and books. However the reading was random and all over the place.

Reading too random
I realised by 2006, that my reading was quite random and not directed. As a result I was reading the entertaining stuff, but not necessarily the dry and important materail such as accounting, AS standards , annual reports etc.

In order to avoid that, i now have a list of topics I want to learn and improve upon. For example, my current year plan includes learning more on behavioral finance, GAAP accounting and arbitrage.

The process
With these topics in mind, I start by looking for books and will list 3-4 books on the topic. Once I have the books I need, I will generally spend 2-3 months or more on that topic. This ensures that I maintain focus on a topic, explore it fully and at the end of it have more depth in it.

As an example, I am current focussing on behavioral finance. I have read 3 books on it already and plan to read 1-2 more books on it. Based on my learnings, I plan to review my current holdings to check my biases and will also be updating my investment templates (see here for the templates).

Additional reading
In addition to the focus topics, I continue reading annual reports and tracking the performance of my current holdings. I am currently not searching for new ideas as my current list of holdings have reached my maximum limit (in terms of number of holdings). As a result I am reviewing my current holdings and will require a new holding to replace an existing one.

The above is a reading/ learning plan. All my blog entries and updates are usually centred around the topics and companies I am reading about. So you can see, the blog is an extension of my learnings and current thoughts.

So in summary I can break down my approach into the following points
– key objective is to learn and be a better investor
– all reading and learning is focussed on the key objective
– The objective would be achieved by identifying areas of learning and then focussing on them one at a time

No shortcuts and magic bullets here !

I received this email from vikas and thought of putting a post on it.

I had a very quick qn for you. How do you manage to find time for your daytime profession, your family and your value investing hobby? Please give me some examples from your daily life. I find myself in a very similar position and I find myself unable to spend anytime learning value investing?

This is an important question, especially for non professional investors like us. Most of us, having a day job, do not have the luxury of being able to spend 8-10 hrs a day reading, analyzing and visiting companies for our investments. So how do I go about it? It is neither a prescription nor some approach, just an idea of what I do.

Lets invert the problem. With limited time, what can I ‘not’ do?

– Cannot track stock prices, volumes etc on an hour by hour basis
– Cannot trade short term, as I may not be able to execute the trade at the right time due to other commitments.
– Cannot analyze more than 30-40 companies in detail or more than 1 or 2 companies per week.
– Cannot track market gossip, chatter, inside news etc.
– Cannot devote more than 10-15 hrs (max of 20 hrs) to investing

With the above constraints in my, I have adopted an investment style, which matches my situation. As regular readers of this blog would have realized, I typically analyze and invest in a limited number of companies. I run a few screens to generate a list of decent ideas, analyze those ideas in detail and invest in a few for the long term.

In addition, I spend 2-3 weeks analyzing a company in detail and build my position over the next few months.

A professional investor would typically be able to devote 50-60 hrs per week on investing. However due to a day job, family and other time constraints, I am able to devote a maximum of 15-20 hrs per week (on average).

I spilt this time between learning value investing, reading up on companies and on this blog. Almost 50-60% of my time is spent on reading up on companies and following my current holdings, 20-30% on learning value investing and the rest on this blog (10-15%).

The other reason for being able to devote 10+ hrs per week on investing is due to the fact that I have no other hobbies or interest (other than watching movies). So I am a pretty dry person with limited interests outside investing 🙂

I am not able to devote 10-20hrs per week every week. There are weeks when, due to job and other constraints, I am able to devote only a few hours a week. During other times, when work is slow, I am able to put more time into investing. In addition, I use my spare time, travel time etc to read books and annual reports.

I have been doing this for the last 10+ years and although the time spent per week or month is small, the learning accumulates over time. The initial few years were spent in learning the basics and there were several times when I felt, I was not making much progress. However over time slow and steady progress adds up.

I eventually plan to invest professionally. The main reason for that is that I am passionate about it and would like to spend more of my working time on it.

The best person to answer the question would of course be my wife and kids who typically see me with a book or on my laptop reading something or engrossed in my thoughts thinking about some investment idea :). Of course my wife does not read this blog …so I am safe!

I think the key to finding time is how passionate or interested you are about investing. Paradoxically if you love the process of learning and investing and are not into it just for the money, you will find time and will enjoy the journey more than the destination (returns in this case).

Added note: I have switched the feed to this blog. There is a re-direct of the old feed to the new one in place. I would appreciate if some one can leave a comment if they are reading this post via their feed.

Next post: How do I plan for investing (if I feel there is interest in the topic)