Where Investors Are Going Wrong

Charles Mackay, in his 1852 classic “Extraordinary Popular Delusions and the Madness of Crowds”, laid down the reasons why retail investors have historically been losing money in the markets. They get influenced by “group think”, a surprisingly common and powerful force in decision making. The paradox is that when a group reaches a decision, it can sometimes be the outcome that no member of the group supports. So, whether it was the Mississippi Scheme or the South Sea Bubble or the Tulip Mania, “Group Think” coupled with greed has wreaked havoc on retail investors in the past centuries in the western world.

Closer home in the Indian capital market, historically, retail investors have been losing money despite the markets giving consistently good returns over the years. Unfortunately, they get into the market only when it has run up significantly over a short period of time. In such situations, mostly, the market price is well ahead of the fundamentals, and the margin of error is limited. Retail investors, after missing out the early and mid-part of the rally, scramble to participate at the fag-end of the upward moving curve. Also, they mostly get influenced by “group think”, rumours and unsubstantiated advice from acquaintances.

More often than not, the retail investor not only makes the error of entering the stocks at an elevated valuation, he also makes the grave error of quitting early when stock prices start correcting. He starts panicking and gets out of the stock, booking a loss. Since he never really had conviction and was only driven by “group think”, he panics quickly and exits.

One of the greatest modern age contrarians is Anthony Bolton, who built Fidelity’s Special Situations Fund into a £3 billion juggernaut under his stewardship. His cautious and sustained growth strategy led to a 14,700 per cent rise in value over 30 years for the fund that he administered. “I get it right about three times out of five,” he says. “I’m a contrarian: when everyone loves something, I shy away from it. When everyone hates something, I want to look at it.”

He says that even if you follow the crowd into the stock market, you don’t have to follow it out, if or when, a bear market comes along. That would be akin to compounding the error. If the fundamentals of your investment are sound, the stocks will recover — and you don’t want someone else to pick up that profit. “A lot of investors get sucked into markets when they are good and shaken out when they are bad,” he says, adding “My advice is to hold on.”

Considering the fact that India is a rapidly growing economy with a gross domestic product (GDP)growth of anywhere between 7-9 per cent, the equity market is undoubtedly the place for investors to build wealth. Assuming a GDP growth of 8 per cent and inflation of around 6 per cent, we are looking at about 14 per cent growth of the economy. Thus, an investor can potentially earn 14 per cent plus returns from his investments in equity, if he is disciplined. Also, long-term equity investment being tax free, this return is post tax. No other asset class can provide such returns under present conditions. However, the investor needs to be disciplined.

For retail investors to benefit in the market, there is a great necessity for detailed research before buying stocks and seeking appropriate advice before doing so. Having purchased stocks, the investor needs to be patient and not panic in situations of short term temporary fluctuations. Markets are volatile and fluctuations are quite normal. For a long-term investor, the focus needs to be on the fundamentals of the market, and the specific industries and stocks that he owns.