Are you fit to invest in stocks?

The advent of 24/7 commentary on TV channels and the popularity of social media forums have spawned a breed of people who think that the real test of an investor (or a fund manager) is his ability to predict exactly how the stock market, or each individual stock price, will move.

Each correct prediction increases in geometric progression the expectation from the next prediction. In reality, it is impossible for anybody to correctly predict all the time, simply because the number of variables that determine the short term price movement of stocks runs literally into the hundreds.

Investors should not even try to do this. Instead, they should focus on what really matters. If we agree that the purpose of the capital market is to reward the efficient use of capital and punish those who fail to do so, we must also agree that the real tasks before an investor is to identify companies that efficiently use their capital, and use his own capital efficiently.

The first would require intelligence and the second the right temperament, which is essentially self-generated. We can call these external and internal factors in investing.

Also Read: Can you get better returns by timing the stock market?

As in any other endeavour, stock market investing needs basic intelligence. The ‘intellect’ part of investing, which deals with the external elements such as economic trends, industry and company fundamentals, FII inflows, etc. are certainly important. But the investor (or a fund manager) also needs the right temperament, which is essentially made up of internal factors. He must be able to:

* Frankly admit what he knows and what he doesn’t.
* Demarcate the risks he is willing to take, and ones to avoid. * Accept that shares of good companies can remain depressed for a long time, or that shares of mediocre companies can shoot up.
* Remain committed (despite acknowledging the previous point) to buy only the kind of shares that he wants to buy.
* Acknowledge that the means are as important as the ends. While most investors attach high importance to the ‘intellect’ part of investing, sadly the vital aspect of temperament gets less attention. This leads to an unfortunate consequence: we expect the world to function the way we want, and become frustrated when it does not.

Many investors are disappointed that the economy did not ‘take off’ as expected after the incumbent government was sworn in with a big majority in May 2014. But if we expect a $2 trillion economy to start soaring within a few months (after a three-year slump) simply because one party won the elections handsomely, we have nobody to blame but ourselves. Having a reasonable expectation from the stock market is therefore the essential first ingredient.
By E.A. Sundaram, Executive Director & CIO – Equities, DHFL Pramerica Asset Managers