The Sensex has been scaling one high after another.
Good news for investors, but also dangerous. Remember, more bad investment decisions are made when the stock market is at a high than at any other time.
All-time highs may be exciting, but at times like these, your thoughts should be on what not to do rather than on what to do.
Ask yourself these there questions to figure out if you have your feet on the ground or are being swayed by the new Sensex highs.
1. Did you do it, or did the market?
A strange occurrence is how investors convince themselves that it is their genius delivering gains, not the market.
Look around. Almost every stock and equity mutual fund is rising sharply. Over the last few years, practically all that has been necessary to get good returns is to just invest. In fact, it has been difficult not to make money in this bull run.
In such a situation, there is a temptation for investors to look at their investment gains and convince themselves of their own investing genius.
As the bull-run goes on, this emotion keeps getting reinforced. By the time the market reaches a peak, there is a large mass of investors who have fully convinced themselves that they are invincible.
And that is when they begin to invest randomly. Typically, investors with this attitude go around looking for stocks that have not yet risen but are 'about to rise'. Late in a rally, these are, almost by definition, dud stocks.
If the rally continues and someone is actively plugging a stock then this works for a while. Eventually, either the stock or the rally runs out of steam and the investor is left holding a stock that has fallen disastrously.
Some such stocks may actually be worth nothing since they are too illiquid to sell.
Our advice: In a strong bull-run, investors must keep both feet on the ground by continuously comparing the investing performance of their entire portfolio (and not just one or two stocks) with some external benchmark. This will keep things in perspective.
Look at all the stocks you have, not just the winners, and see how they have fared when compared to the Sensex and other stocks in that sector.
Similarly, compare your mutual funds with other similar funds and the fund's benchmark. If the fund has benchmarked itself against the Sensex, compare the performance with its rise.
2. Is there a substitute for knowledge and understanding?
A couple of years ago, when the stock market was in the dumps, few made an investment without putting it under a magnifying glass.
But, as the market rose, most people appeared to need fewer and fewer justifications for investing.
When the market picked up, the focus shifted to what one may call faith-based investing.
Investors have faith in the general talk of how the markets will keep on rising and therefore find almost any investment worth making, regardless of how little they know about it.
The feeling is that the markets will go on rising and therefore all stocks are worth investing in.
This zero-knowledge investing is a recipe for disaster. Since investors get into a stock or a sector without knowing why they are there, they cannot figure out when to get out and whether or not it is time to do so.
The rash of sector funds launched lately indicates that even mutual fund investors are prone to investing without understanding.
Fund investors with perfectly well-balanced portfolios are going around putting money in sector funds without even understanding them. Moreover, they have not even figured their own pre-existing exposure to those sectors. Probably, they already have invested in such stocks on their own or in funds which have bought the stocks of such companies. Do they really need a sector fund?
Our advice: Do not invest in stocks, sectors and funds that you do not understand. And if you do not have the time or the inclination to understand anything specific, stick to a handful of mainstream diversified equity funds and balanced funds (funds that invest in shares and fixed-return instruments).
3. Are you being swayed by the media?
Be it the newspapers, magazines or the business television channels, all see their business improve when the market goes up.
Good news sells, bad news doesn't.
All this creates a frenzied atmosphere that drives people to invest NOW! The feeling is that one will miss a lifetime's opportunity by not investing immediately. This invariably leads to bad investment decisions.
At such times, it's easy to forget whether the stocks you are getting into are good value at the price you are paying. There are plenty of good stocks that are just too overpriced at a point like this.
As someone observed recently, brokers appear to be hawking many more buys when the Sensex is at 9,000 than when it was at 5,000. This doesn't sound like rational investing.
Surely, if one is evaluating a bunch of companies as potential investments, there would at least be some that would be worth investing at lower prices but not at current ones.
It doesn't sound likely that the number of worthwhile investments would actually rise when the market does. Yet, if one is to look at the 'research' that is being churned out, there are more 'buys' now than earlier.
Clearly, researchers and investors have stopped looking at whether some investments are justifiable at current prices.
Our advice: Invest in a stock only if you believe in it and are planning to hold onto it for a long period of time. Don't pick it up because you got a 'hot tip'.
