I don’t know why 21st century makes us so much objective driven that we justify our existence solely on the personal outcomes achieved at work place. Objective driven approach makes us blind to the emotions and feelings of others . We tend to lose sympathy with people, as our attachment to results increase. Sometimes these are our own created desires and sometimes they are driven by corporate incentives created to drive results in short period of time, ignoring the means underneath .
It pains me deeply when work leads people to develop hatred and anger towards their co-workers. While it may be right that the person one is anguished about is not moral or intelligent or rational than us, but I always wonder, is hatred or anguish still justified? I have seen people’s hatred gone to extreme levels to wish all kinds of ill will, and bad outcomes for the other person. It is even more abominable when such feelings are directed towards people who are 10-20 years older than yourself and of one’s father’s age.
Moral ethics have always preached us to respect the elders, even if they are wrong. You may try to show them the right path, if they happen to do wrong sometimes, but it never taught to hate or aspire evil to them , even at the course of personal loss. It was meant out of deep love of humanity. Everyone has that good side of theirs, which gets clouded in daily affairs. These people , who may be doing wrong to you, also have a family , are a father, mother, son, or daughter to someone. There is someone who is waiting for them every evening, like our own family . It never justifies this feeling to desire bad health or evil for anyone, at any cost.
I am more and more realising that the work done is of no value, if the feelings behind it are not of love and sympathy . I would not want to accomplish any task , no matter how relevant to my existence, my organisation or state, if my underneath feelings are ill-intended . May God give me wisdom to act in the above manner and never be blinded to accomplish results.
With this approach, you may not reach to the zenith of the artificially designed hierarchical status in the corporations , but your heart and conscience will be content that you did justice to your existence in the world. When others around us are immoral or irrational or unjust, it provides us a much bigger reason to be otherwise. It is very easy to term this approach as impractical. It is certainly difficult, but we can take solace from the fact that we have cracked so many challenges in life with our hard work, so why not this!
There is no end to the trap of achievements. I don’t even know , even if we achieve everything, get all tasks completed as we desire , what would we get in the end? What value is it without the right feelings underneath that work. !
Covid-19 lockdown provided me sufficient time and mental peace to rethink the approach in life, my philosophies and the fundamentals I believe in. This naturally extended to reviewing my investing skills and principles, wherein I got to objectively relook at my successes/failures, and assess my decision- making approach . I am grateful to be able to utilise this time , and hope that it has provided me with significant leverage to sharpen my principles for becoming a better investor in future.
Below are the six principles that I adopted or re-emphasized during this period-
1. Quality Companies as a Business Owner
I will only own quality companies , and aim for an indefinite duration of holding, unless the business economics prompts me to do otherwise. Owning stocks is owning the business, not just electronic money trading instrument. I would want to be a part of the business, its challenges , growth and be with it throughput the journey .
2. Stricter value standards
My Value Standards for finding investments have even gone stricter than the past. I am demanding even higher margins of safety , as a strict selection criteria, to decrease possibility of capital loss and generate higher than Overall market returns (Nifty/Sensex). Unless there is significantly high odds of beating the market (by at least 3% CAGR), I would pass the opportunity and rather invest in the index, or other vehicles.
3. Sitting-idle and not investing and rejecting majority investment opportunities is great
This is about acceptance that good ideas will be very rare. We are all so prone to action and associate our success with only making an action. Sitting idle and waiting for a long period of time, without investing till my strict criteria are met will hold a key in my long-term success and must be cherished . Too much action will be cautioned against. Finding 8 potential investment opportunities in a year, and investing in all of them will not be entertained. Each and every opportunity must be assessed with regards to the current businesses I own, and maximum of 2-3 would be chosen to invest at a given period of time .
4. Consolidation of Portfolio –
I sold my investments in those Businesses that were lousy (low ROCE) or the ones I didn’t understand clearly. No matter how good or bad returns they had given in the recent past, I ended up selling them to consolidate my portfolio. While I held 30 companies before the lockdown , the consolidation helped me to cut to 18. My next phase of downsizing will aim for another sequence of consolidation to bring number close to 10 or even less. I will invest only in businesses that I understand, and want to be associated with it for a significantly long duration.Over-diversification will not be entertained, at any costs. If every my instincts go towards over-diversification, I must buy ETFs/Index funds and stop this exercise of picking individual companies.
5. Tracking My investments
My philosophy for tracking investments has been altered. Rather than tracking the market prices (every year), I would rather focus on tracking the earnings of each business I own every year. If I ran my own company, I would only focus on my cash profits and not at what it is being valued in the market place.
Looking at market prices , if used, will only be to either buy more with lower prices or Sell if the business economics suffer badly. The market will only be used for my benefits and would not influence my decisions in long term investing.
6. High CAPEX Businesses
Economic depressions bring out the inherent risks in high capex businesses. The high capital investment creates a major cash drag in these firms during bad times. Unless theses business involves essential products and services (which are demanded in all weather conditions), they are open to cash burns and high debts in bad times.. Investing in these firms, if possible must be avoided, and should only be done at even higher margins of safety than other low CAPEX businesses, to avoid loss of capital .
I have always been a big fan of Test Cricket and despite the fading popularity it currently faces now, it has given me the best memories of my childhood and continue to provide me wisdom and guidance on my journey in life .
The most exciting part of a test cricket is when a new batsman walks in the crease , is surrounded by fielders , and facing swinging fast deliveries . But, Test cricket provides him the luxury of not being hurried up to score unless he is well adjusted to the environment, is relaxed and calm to play his shots. He can leave as much tough deliveries as he wants and wait for the right ones that fall in his strength zone , to score. Throughout his innings, the opposition will aim to arouse him by fast bouncers, as well as verbal comments . But , the beauty lies in the fact that chosing his response lies completely in his domain and he is not bound . He can treat these arousal tactics as an injury to his self-respect and become aggressive and succumb to their tactics. Alternatively, he can chose to take the high-road and continues to perform and answer the opposition with his batting without getting deflected at the job he is there to do at the middle,
Life is similar.
We encounter conditions and competitiveness in life similar to a cricket test match. In the rules of the life-game, there are bowlers who are regularly pitching at you with threats as well opportunities. A classic corollary is at workplace , where you will be regularly getting into political situations aimed to frustrate you, excite you and do certain acts . But, with life being a test cricket, you are at luxury to not succumb to such acts and pressures . Unlike in ODIs or T20s, you are not bound by time to score , one is at liberty to leave as many difficult deliveries (the ones which are not in the zone of competence) and chose the ones to hit and still score a double-century. You need to just hang in there, wait for the balls pitched in your zone, and score at your own pace. Doing so consistently will make you do fine in life.
The skills of playing in a test match are different from the shorter formats . Test Cricket teaches all the age old wisdom of patience, mental fortitude and discipline. Tendulkar’s innings at Sydney was a reminder of how mental strength, fortitude and discipline can breed success. He decided to not hit cover drives, as he had got out multiple times in the series playing that shot. To be able to do that for 800 mins in the middle is incredible mental strength.
As Rahul Dravid said “In a cricket career, your life is in some ways controlled for you. You have no control over schedules, you have no control about where you want to play, you don’t have control over that as a cricketer.” Similarly in life, we are playing roles in various games and some things are laid out for you. You dont and wont have absolute control over that . We need to accept that and learn to grow with that.
With regards to value investing approach, a majority of financial articles published in the top financial papers/magazines tell you to find and invest in undervalued stocks that have fallen the most, and currently have low P/E ratios. Retail investors are bombarded with information on low P/E stocks trading in the market and available at significant bargains. This metric makes one believe that a stock trading at P/E of 10 is a better investment than a different stock trading at P/E of 50.
However, one must understand how this can be severely wrong. The below example illustrates this point with the concept of Return on Capital (ROC).
Return on capital employed in a business is a fundamental and most important parameter to assess its capability to generate earnings.
Return on Capital is defined as a ratio of the Annual Earnings out of a business to Capital employed . Lets look at this through a very simple example.
ROC = Earnings/Capital
Business A generates $ 10 annual revenue for $ 100 capital invested into it. Business B generates $ 15 on $ 50 invested. The return on capital ratios highlight that Business B has a capability to generate higher returns than Business A on same capital invested. This also translates to the fact that if Business A needs to expand and increase its earnings, for every $ 10 increase in earnings , it will need to invest additional $ 100 (Assuming ROC remains unchanged), while Business B can increase $ 10 earnings by investing only $ 33 (ie 66% less capital). Business B is a comparatively wonderful business as it allows you to grow rapidly with lesser capital.
Now lets take the perspective of a stock market investor , if he intends to buy stocks of these two businesses. The below table highlights various scenarios and your likely returns in the two businesses over a 5-10-15 yr period.
For Business A, it is assumed that average long-term PE of this industry is 10. If you happen to buy the stock at even 25% discount to avg P/E , you can earn 16% annual CAGR for 5 years. As the period increases, it will go down and will converge closer to 10% (which is the Return on Capital).
Looking at Business B, even if you happen to buy the share at P/E of 60, you will earn 19.8% in 5 years.
The above example highlights Munger’s principle “It is better to buy great businesses (which are high ROC ) at fair price , than buying lousy businesses (low ROC) at great prices”. The above scenario clearly depicts that even if you pay a bit more to buy a great business, compared to buying a low ROC business at a discount, you will be able to compound your investments at a higher rate in a great businesses . Additionally, the longer your holding period is, the more your returns will ultimately converge towards the sustainable Return on Capital.
The above example also highlights why PE should not be a major metric to decide your investments
The past couple of weeks in the financial markets was a testimony to the fundamentals of investing and my belief in them . Until Feb 2020, investors were enjoying a long period of bull ride resulting into significant regular monthly investments in the equity mutual funds/ high performing stocks which had maintained a track record of 13-15% returns over the past half a decade. A majority of the new retail investors felt that they have found a simple gold mine to make significant returns (through smart & intelligent fund managers who are being paid to just do this) and started thinking to themselves ” why did the previous generation of parents and grandparents miss this route to make money. Why did they continue to invest in Fixed deposits or PFs or PPFs neglecting the earning potential of Corporations “.
As has always been the case in downfalls, markets need a prick to return to fundamentals and this time it was Covid -19 which led to severe downfall in the market valuation . The bullishness suddenly converted into fear as the global markets collapsed and investors rushed out of the markets and started doubting their investing philosophy that they had been religiously following for 3-5 years, thanks to the past performance, social pressures and aggressive marketing by AMCs. Majority of these investors were first-timers and were ready for minor fluctuations in the market (negative 10-15%), but not at the levels seen in a week. The inexperience of dealing in these type of events eventually led to a panic for a significant number of retail investors.
Here are the beliefs and emotions that I have been observing in the market place over the past 3 years , eventually leading upto the current market situation –
Excessive bullishness and above average past returns – The successful 1-3-5 year returns of mutual funds brought excessive bullishness in their potential . A major lot of investors who had been investing in SIPs in mutual funds continued doing so , without being aware of the burgeoning valuations in the market as they steeped up their returns .
On the contrary , major reputed investors (Warren Buffet or Howard Marks) have been for quite a long time now, doubting the capability of markets at current valuation to sustain . A significant lot of other experienced investors also had a sense of bubble in the market, however, as is typical, no one could predict the timing of a possible crash. Fund managers whose livelihood depends on “Assets Under Management” naturally convinced retail investors of the continued possibility of higher returns in the market. Unfortunately, their advice was flooded in all sources , be it newspapers or TV channels . The information overload of such advice along with the inertia of continuing SIPs , led to retail investors continuing the path of equity investing (via stocks/SIPs) even in an overvalued market.
Secondly, even if some investors had a sense of market overvaluation, there was a fear of losing out. They didn’t want to go against the inertia and current trend when they can’t predict the timing of market correction . Added with it , the scare that if the market downfall doesn’t happen for next 1-2-3 years, they will miss the bus and the possible opportunity for higher returns. These thoughts eventually led to a decision to stay invested than miss out the bus even if they weren’t fully sure of the rationality of the decision.
Fundamentals of investing requires you to be aware of your odds of success in the market place. Every investment you make in the market (even if it is a fixed monthly investment you make via SIPs in the funds) need to be rationally evaluated against the second alternate investment class (lets say the fixed deposits to be simple). The higher the prevailing market valuation, the lower becomes your chances of beating Fixed Deposit/PF , not eliminating the increased possibilities of significant capital loss. Awareness of this fact should rationally lead an investor to be conservative and cautious while investing the hard-earned money. Successful investors who make money in long run are able to hold off their zeal to invest in equity markets for years, till the time the valuation is justified within their range. This was the major reason why Buffett kept sitting on a pile of cash for long and Howard Marks warned investors to be cautious in investing in market in current scenario.
All of a sudden a 30%+ drop in equity portfolio led to shocks which impacted the investors’ capabilities to take the benefits
When investors suddenly see their portfolio (which was 15% up and is currently down by 20% in two weeks ie overall 35% decline), it leads to a bearish situation where the first course of action is to stop their regular investments, forget about increasing the amount of investments in these tough times. The shock of sudden loss overpowers any thinking of a favourable scenario in the future.
The above graph depicts how proportionate fall in your portfolio valuation hampers your psychological nerve to invest further.
If you had decided to stop your equity investments in the overvalued market situation for quite some time now (as described in point No. 1), and rather preserved cash, it would have been a prudent strategy . This would have helped in two ways- Firstly, it would have decreased your probability of loss and secondly, provided available capital to take advantage of market downfall .
Wisdom advices you “to preserve sufficient cash/liquidity to keep your expenses going. Market downturns can be associated with situations of job losses and having funds in such scenario is critical for emergency personal expenses as well as to jump on investing during the market crash opportunities
Fear of Missing Out in market downturns – Even for those, who have been waiting for such opportunities by preserving cash to invest, psychological challenges remain on the ability to make sound investments and maximising returns.
One of the major emotion is ” Greed and Fear Of Missing Out” in such market crash opportunities. It is natural that there are two possibilities- market may go up from here, or may further go down. These opportunistic investors are always worried about the scenario of market going up from here (what if suddenly tomorrow market jumps 15% up and this downfall was short-lived) and they don’t deploy all capital and miss out on low valuations . On the other hand, they are worried if the market drops another 20% in another week and they don’t have additional money to deploy. Sometimes , this pyschological behaviour also leads them to borrow additional money to continue taking advantage of low valuations. It brings a mental conflict on how to effectively deploy the capital.
One of things to remember here is that it is a factor of luck and is completely un-predictible whether market will go up or down tomorrow, a week from now and so -on. No-one can be perfect to be able to time the market and invest at the lowest valuation points. It might happen out of luck with a few investors, but would be very low % of total investors. Trying to aim for such outcome will only lead to stress and psychological dysfunction affecting rationality. As Howard Marks mentions “the best way is to spend a part of your targeted investment . Tomorrow, if the market goes up, you’ll be glad you bought some. Alternatively, if it continues to go down, you’ll still have money left and hopefully the pyschological nerve to buy more.”
Not maintaining an optimum Fixed Income/Equity ratio , believing simply in Formulas propagated by Fund Managers.
A lot of investors blindly believe in the magic formula –
Equity investment (% of portfolio) = 100- Age
Lets take a classic example of a 30 year old young investor. Lets assume his total wealth is 50 lakhs (he has no other assets) . If he believes in the classic formula (Case 1), he would have 35 lakh (70%) in equity and 15 lakh in fixed income at one given point. Lets look at variations of his portfolio in three scenarios- Good Times, Normal Times and Depression /Crashes.
Case 2 compares a fairly conservative portfolio distribution of the same individual (now 70% fixed income investment and 30% in equity)
Typically, when one structures his portfolio with higher equity proportion, he considers fixed income as a return destroyer. As given in table in Case 1, his portfolio fluctuates between 16% in good times, 9% in normal times and upto -33% in depressions/crashes. Even if you may have time at your side to recover losses during crashes, the question remains whether you have the appetite and capability to bear loss of a third of your wealth at any given time, as well as your mental strength to continue investing in such market crash situations. Some people get overwhelmed by one time losses that , forget about their abilities to further invest to take benefits of market crash, they eventually exit the market altogether.
Equity: + 20% Fixed Income: + 7% “Good Times”
Equity: + 10% Fixed Income: +7% ” Normal Times”
Equity: (-50%) Fixed Income : 7% ” Depression/Crashes”
Portfolios return : 16% (+8 lakhs)
Portfolio Return: 9.1% (+4.5 lakhs)
Portfolio Return : -33% (-17 lakhs)
Case 1 : 70% Portfolio in Equity
Equity : + 20% Fixed Income : + 7% “Good Times”
Equity: + 10% Fixed Income: +7% ” Normal Times”
Equity: (-50%) Fixed Income : 7% ” Depression/Crashes”
Portfolio Return: 10.9% (+ 5.45 lakhs)
Portfolio Return : 7.9% (+3,95 lakhs)
Portfolio Return : -10.1% (-5 lakhs)
Case 2 : 30% Portfolio in Equity
In Case 2, on the other hand, his portfolio fluctuates between 10.9% in good times, to 7.9% in normal times and worst case scenario of -10% in depression times” . A person in such portfolio structure would not lose more than 10% even in the worst case scenario . He is more likely to be psychologically sound and continue investing to take benefit of market falls.
Consider these situations and take your time to think on how would you want your portfolio to be structured for mental stability and long-term superior returns. This is the most important decision to keep you winning in the long-run.
In today’s world, information is aplenty. With the explosion of content on internet , significant personal stories of success in specific fields are available for everyone to read. They range from ideas to succeed in workplace, be a star performing fitness athlete , be socially active and likeable, making travel as your profession, working remotely etc. While we, the millennials, regularly read tons of such ideas, we are unable to apply almost 99% + of them in real life. They look motivating and inspiring at the moment you are reading, but not powerful enough to retain and impractical to apply in our personal circumstances.
It is easy to write about ” F**K your job ” or “Live Independently” on your terms, when you are earning a good income as a freelancer or blogger, but not so much for a regular employee or when you are in debt with a mortgage. It is very easy to be calm , composed and sane when you are on vacation lying around beachside or pool. It is easier to be an athlete when your profession is fitness. It is relatively easier to be an investor , when you do it full-time. It is easy to be ethical till the time you haven’t been exposed to an ethical dilemma.
The Sanity in each aspect of life lies in activity, not idleness. It is during daily intense activities we tend to lose calmness, peace of mind and build-up frustration. It is easier to feel good reading articles on philosophy, but difficult to remain the same once you go back in real world.
As stated in Bhagavad Gita, the real test of a man’s character is in his ability to stay sane during intense chaos that we experience in our daily lives . This is essentially what I mean by “Sanity in Insanity”. For example- It is our ability to remain sane during intense work pressures. It is our ability to remain sane when things don’t go as per plan or our desires . It is our ability to be a good decision maker and be true to your value system, in such situations of intense activities. If you are having tough time at work, it is not about taking a year off (from work and away from family) to travel the world and get to know yourself. It is not about escaping the situation and consciously ignoring the issues , but consciously act sane and find peace while facing the challenges at hand. Sanity in Insanity is about behaving and acting sane in all such situations. It is about continuing to be a loving parent , spouse and a rational human being every day of life.
In this article, I am not suggesting that we should accept all situations in our lives and try not to change our circumstances, but rather consciously act sane in all environments or situations. We should recognise that a noble person behaves and acts with utmost sanity in even insane , and chaotic environments. We should understand and appreciate that the environment we live in will always be chaotic and some of the elements will be beyond our control. However, as a rational human being, we should act sane and display tranquility in all situations . Then and only then, we can take the right and rational steps to change some aspects of our lives that lie within our power.