Falling markets: Top tips for you

Many a times, on a clear night, when I look up at the stars, I can't help but wonder whether there is intelligent life out there - or are they just like us?

Till May 10 everything was fine. The stock market was our darling. We couldn't have enough of shares, mutual funds, systematic investment plans, IPOs and New Fund Offers. And why not? Yes, there was that bit of extra risk but hasn't equity been known to outperform all other asset classes over time? So, we weren't worried, because you see, we were the Long Term Investors.

The Sensex at that time was 12612…but that really doesn't matter to the Long Term Investor. Cut to 7 days later. May 18, 2006. Sensex at 11391.

It's as if all hell's broken loose. The phone won't stop ringing. However, each time it's answered, the voice on the other side shouts the same word: SELL!

Seven days. That's all it took to break down the Long Term Investor. Putting it in other words, it just required a fall of 10 per cent to completely wipe out the tribe of the Long Term Investor. Over night we have been overcome with self-doubt. Is the market too expensive? Are the valuations stretched? Should we book profits and stay in cash? Will this correction be more severe? How do we play this situation?

That in itself is the mistake…

Well, I suggest, lets try and keep our eyes on the ball and not the situation. First of all, we all agree that these questions if at all, can only be answered, by someone who can look into the future. Now, since we don't have the ability, the next best thing I propose we can do is use two tools that will help us tackle each delivery to the best of our ability. And what are these?

• The power of compounding, and
• Long-term investing

Albert Einstein called compounding the eighth wonder of the world. And just how smart Albert really was can be gauged by the following story.

This is a story in which a simpleton of a king lost a well-fought game of chess to an ordinary farmer. The king asked the farmer to choose his reward and all that the farmer asked for was 1 grain of wheat for the first square of the chess board, 2 grains for the second square, 4 grains for the third, 8 for the fourth and so on and so forth for all the 64 squares. The king was very happy for being let off rather lightly and readily granted the wish. The real snag came when he tried to settle the claim.

He required 18,446,744,073,709,551,615 grains of wheat!

Now isn't that mind-boggling? Let me try to be more concrete. There are about 25,000 grains in 1 kg of wheat. The king required about 7,37,870 million tonnes of wheat to fulfill his obligation. Now, here are some statistics for comparison. Our total national agricultural produce (wheat, rice, sugarcane, cotton, etc.) in the year 2004 was around 200 million tonnes. The required quantity of wheat is about 3,690 times this amount. Even all the wheat produced by man from all over the world, ever since he learnt the art of cultivation will be far less than this quantity. If the king had decided to settle this liability in cash, say at a super wholesale rate of Rs 3.50 per kg, he would be required to pay Rs 25,82,54,417 crore. This is over 2000 times the Indian Gross National Product, which is the total value of all, industrial as well as agricultural, goods and services produced by India.

What happened there was that the smart farmer used the power of compounding to his advantage. And such is the power that the king didn't know what hit him. Realise that things were fine till the first few squares. It was only by the 10th square or so that it went out of hand. In other words, compounding, though the eighth wonder, only works if used over the long-term. In fact, long-term investing and compounding are two sides of the same coin - one cannot exist without the other.

Have a look at the following scheme returns:

(Annualised returns as on 30th April 2006)

In all there are over 200 equity-oriented schemes operating in the market and the above selection is just an example of some well performing equity schemes. Of course there are other schemes whose performance has been good, the only point here is to showcase how compounding actually works.

Will such returns be repeated in the future? I don't know. Will such returns be NOT repeated in the future? Again I don't know!

What I do know however is what the world went through in the past five years: the dot com bust, September 11, Afghanistan, Iraq, Greenspan swinging rates up, then down and then up again, oil shocks, domestically too, Parekh came and left, the Left came but is yet to leave, Brothers Ambani split. And all this while, quietly in the background, King Compounding was at work. Those who had the faith are raking it in today.

Which brings me to wonder how many of us really invest for the long-term? Warren Buffet himself says that a total of twenty trades is more than enough in the lifetime of any investor. Though that may be stretching things a bit, I cannot help but wonder whether our parents and their parents had always got it right when they bought their shares, put them into the family trunk and forgot about it.

A kind of 'Fill it-Shut it-Forget it' investment strategy that indeed paid handsome dividends over time. In the absence of social security, our senior citizens largely depend upon these blue chips accumulated over a lifetime to tide them through. And the way things are currently, social security is not coming anytime soon, but will we have the 'blue chips' to fall back upon?

Investing is hard work indeed. No wonder the word 'work' is always prefixed with the adjective 'hard'. Having to earn a living is no walk in the park, what with trying to keep the nose to the grindstone, shoulders to the wheel, eye on the ball and ears to the ground. One rarely has the time, energy and inclination to worry about when, where and how to invest.

So let me share with you the secret of successful investors. This is a magic mantra and has worked for many and I hope you too use it in your life. The mantra is: Persistence. Nothing in the world can take the place of persistence. Talent will not, nothing is more common that unsuccessful people with talent.

Genius will not, unrewarded genius is almost a proverb. Education will not, the world is full of educated derelicts. Persistence and conviction alone are the key. In other words, time in the market and not timing the market is what makes the difference between a successful investor and an also-ran.

Therefore, I think I'll just let King Compounding do the job for me. Efficiently and silently as it has been doing throughout history.

I hope the Long-Term Investor is listening.

The author is an investment advisor. He can be reached at sandeep.shanbhag@gmail.com.

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