Investment guru Benjamin Graham had once said that stock markets are like voting machines in the short-term, but are like weighing machines in the long-term.
The results in a voting machine change as a function of what the voter thinks and votes for. In the stock market parlance, the voters are the buyers and sellers and it is their action, which is akin to voting.
However, movement of the same stock prices depend on the profitability of the underlying companies over time and hence the weighing machine analogy. If that is the case, then the short-term movement of prices may not have any relation with the long-term movements.
However, the human mind generally extrapolates the short-term movements while taking long-term investment decisions. What is the ideal way of assessing the stock prices then?
Some of the greatest investors the world has seen generally ignore the short-term movement of the prices and focus only on the long-term performance of the companies, whose stocks they have bought.
If the investor is convinced about the ability of the company and the management to increase profits over a sustainable period and if the current price is attractive, such an investor would buy and continue to hold the stock. However, there would be many ups and downs.
So what is the lesson for the investor? One, good amount of work may be required to be done before one invests. Two, after having invested after doing the required homework, one has to have faith and patience. Many times, an investor puts his money in a risky security - be it a stock or an equity mutual fund - and then is nervous about the price movement from then on.
This is reminiscent of how a student buys books after the exams. That is exactly how an investor behaves. Preparation has to be done before the exam. Preparation or homework here refers to the assessment of the investment option.
The second point pertains to patience. It is a rare virtue, and not only in investments. Let us look at a real life example, which has nothing to do with investments.
While travelling by air, I have often observed an interesting behaviour. Even as the plane is taxiing, people unbuckle their seat belts and start taking the luggage from the overhead compartments.
Now, come to think of it, the plane would taxi for a while before it stops, then the ladder would appear. Only after that one can exit the plane. When you reach the airport terminal, you have to wait for your checked-in baggage. If this is the sequence one has to compulsorily follow, why get up even before the plane stops and stand uncomfortably in a queue!
We are generally in an unexplainable hurry. The above example would be laughed off as one can relate to and understand as what would constitute the appropriate behaviour.
However, when the outcome of the action is somewhere in the distant future, the anxiety gets the better of us. Add to that your hard-earned money. A small degree of price movement and one seeks an immediate answer, explanation or reassurance.
The 2007 Budget marked the 10th anniversary of the "Dream Budget" presented by the current Union Finance Minister P Chidambaram. However, the dream of many turned into nightmares on Budget day, given the fall in the value of the bell-weather index - Sensex.
An investment advisor received a call from one of his investors asking him if one should panic. Well, is there ever a need to panic? Let us look at the dictionary meaning of the word "panic".
As a verb, Panic means "to cause or to experience panic" and panic, as a noun, means "a sudden unreasonable fear which overpowers". The word "unreasonable" is the key. If such a fear is unreasonable, should a rational human being ever panic? The question on if one should panic is like asking someone whether there is a need to commit suicide. Yes,
people, panic, like they commit suicide or murder, but there is never a need for any such action.
The ancient proverb "patience pays" is most relevant in stock markets since the long-term movements of prices are more predictable than the short-term movements.
Doing one's homework before investment and then having faith, of course with periodic review, would go a long way in creating wealth for the investor. If the assessment is correct and your review process is sound enough, you are more likely to create wealth. The only thing that you need along the way is to have patience and not get disturbed.
The writer works with a leading mutual fund and the views expressed are his personal views
