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Can investors afford to shun the market?

It must be kept in mind that over the long term, stock markets have provided decent returns

SHARE MARKETS anywhere are either the most favourite or the most hated entity, depending on what state the markets are in. A rising market is characterised by the build-up of a herd mentality; everyone wants to be part of it. If the index goes up continuously for 15 days, there is a sudden spurt in interest, and everyone starts talking about what to buy. If the market falls drastically, the stock market becomes a most hated object, and calls from brokers are shunned.

Indian bourses are going through a similar phase now. There has been an almost 25 per cent fall in the broad index, while the drop in the prices of widely traded software stocks has been far greater - in many cases as high as 90 per cent. Everyone says that investors have gone away from the markets and that they are not likely to come back in the near future.

But it is precisely at such a time that one has to ask the question: Can investors afford to stay away from the share markets? The answer is a decisive NO! The reasons are not far to seek.

Savings essential

In India there are no social security schemes worth the name, nor is there the kind of comprehensive and reliable medical insurance cover that people can feel confident about. Because of the absence of such safety nets — which are common, and taken for granted, in developed countries - Indians necessarily have to save for their old age. The savings have to take care of not only their day-to-day expenses, but also provide for meeting family and social obligations such as children's education and marriage. On top of this, a cushion has to be built to take care of the medical needs and emergencies that come with old age.

These are the compulsions that have led to high saving rates in India — 25-27 per cent of GDP — which are among the highest savings rates in the world.

Of course, the savings have to earn interest. The interest earned has to be higher than the rate of inflation. If this is not the case, it means that savings are being devalued with time. The interest rate curve in India has been falling rapidly. Over the past six years, interest rates of banks and various government savings schemes have dropped by over 50 per cent. So it is clear that one cannot count only on interest income.

An inflation beater

It is in such a scenario that stock markets come to the rescue of savers. Stocks have consistently provided higher returns than fixed income savings avenues. For this reason, stocks have to be an essential part of an investment portfolio. It is stocks that provide the power to beat inflation. Nothing else can take their place.

At the same time one hears stories about people losing money in the stock markets. Where are the gains? Who are the winners? To answer this question, one has to go into people's attitude towards share investments. Do they perceive shares as investments or as a form of lottery that will provide a jackpot in the near future?

Any investment proposal needs to be evaluated in terms of the returns it will provide, and the time period over which the returns will come. However, while buying shares, most investors do not target specific levels of return. Furthermore, the downside risk is rarely considered. Psychologically, few are ready to accept the possibility that their capital is exposed to some degree of risk.

People should remember one thing; crorepatis may be made on the KBC shows. But the share market is definitely not the place to look for a jackpot. However, over the long term, share markets have normally provided returns averaging 15-20 per cent. Anything more than this should be considered abnormal. Of course, there are times when share prices jump much more than this - but the ones who really benefit are those who cash in their gains. Investors should not belittle the 15-20 per cent annual gain that shares have been giving. Over time — and with compounding — this will make a huge difference.

Money can be made on the share markets only if targets are set for the profits that one wishes to make. At the same time, a stop loss limit should be set in advance. For example: suppose an investor wishes to earn a return of 30 per cent in a year. In that case, the portfolio may be rotated thrice a year, with a 10 per cent target profit each time the investor enters and exits the market. In the same way, if there is a 10 per cent loss, one must exit the share. With such targets, one can avoid making sizable losses. Such targets are achievable. One could try this theory out on a mock portfolio. Even if profits are not targeted, the stop loss must be set, even if the purchases are for delivery. The availability of demat facility makes entry and exit extremely easy.

Investors who have speculative tendencies should dabble in the options market, rather then be day traders in the cash market.

The portfolio has to be structured on the basis of the frequency of income flows and capital return one requires. The composition of the portfolio also depends on one's age, status in life, other sources of income and risk bearing capacity. It is not wise to put all of one's eggs in the share market basket alone as it can, at times, turn risky. Persons with fewer social obligations can afford to put more money in the share market, whereas a senior citizen can allocate just 5 per cent of his wealth for shares. Investors need to spend time to build portfolios that suit their individual needs.

Last, a word of caution about the advice given by brokers. Unless one's broker is a registered portfolio advisor, he will not be tracking his client's portfolio. He will merely give his view on the market and on the stocks that are current favorites. His view is essentially a short-term view. He is too close to the market and is affected by short-term price movements and changes in sentiment. Without a full-fledged research department, he cannot make an in-depth study and provide a long-term view about different stocks.

In such a situation, it will be advisable to track one's own stocks. One should not expect one's broker to give the signals. It is one's money that is at stake. One must manage it by setting - and sticking to - the buy and sell targets. Even if a share has been bought on a broker's advice, it is necessary to dispose of it when one has achieved one's targeted return. Goals must be small as they are not difficult to achieve.

Investors should remember the advice about profit and stop loss. Most of the money lost in share markets is due to greed and the fear of taking a loss. Investors do not sell because they want to wait for the highest price. But few are able to sell at the top - getting the exact timing is almost impossible! Similarly, investors are afraid to book a loss that has already occurred. So they let things drag on — and then they sell at a much bigger loss. Sometimes, they wait so long that the shares become worthless. One should keep in mind that no complex or sophisticated study is needed to operate prudently and successfully in the stock market. Investors must keep their emotions in check. What is really needed is a lot of common sense.

DEENA A. MEHTA

Former Vice President, The Stock Exchange, Mumbai

She can be contacted at: deena.mehta@envestmentz.co.in

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