How to be an intelligent investor

When do we like to purchase any goods or services - when their prices are high or when they are low? Are discounts good for us or are they bad? While all of us run when we hear word discount and sale, our actions are exactly opposite when it comes to equity investing.

Legendary investor Benjamin Graham in his book "The Intelligent Investor" has stated that stocks become more risky when prices are high and less risky when prices are low. This we know is also true for all our purchases. Goods and services are less attractive when prices are high and more attractive when prices are low. However while investing in equity markets we sell our stocks when prices are falling (low) and when they are rising we feel safe to invest.

Investing is a strange business. It's the only one we know of where the more expensive the products get, the more customers want to buy them - Anthony M Gallea

In year 2002 when equity markets were at its bottom after technology bubble had busted, one of my new client was shocked when I recommend 25% of his allocation into equity. According to him equity market was speculation den. Same client about six months ago called me up to check if it was alright to park his entire PPF maturity proceeds into equity.

Another interesting observation made by Benjamin Graham is that an individual considers someone a speculator if that person was to invest in equity markets after they have fallen massively – say may be after a bubble burst. Same individual will treat someone as an investor when that person invests into equity markets after they have risen sharply. What is more speculative in nature - to invest at low levels or high levels?

Since it is difficult to see future, we take shelter in past to predict future. It is like driving the car by only looking into rear view mirror. Rear view mirror only reflects the road, which has already been traveled. The reason we consider an investor speculator when he invest after markets have fallen is because we are referring our judgment on past events. The same is true when we refer to someone as an investor after markets have risen. However we all know that “past performance may or may not be repeated” – To drive ahead we need to look in front and not in rear view mirror.

It is common sense that to earn good returns we need to buy low and sell high. This also means sailing against the tide. Buy when everyone is selling and sell when everyone is buying. This strategy is called contrarian strategy.

It takes patience, discipline and courage to follow the contrarian route to investment success: to buy when others are despondently selling, to sell when others are avidly buying - Sir John Templeton

The reason Sir John Templeton says it requires courage to be contrarian is because as human beings we prefer being with the crowd. We are not comfortable being seen opposite the crowd. When we are on opposite side of the crowd whole world can see us. We feel that if we make mistake then crowd will laugh at us. On the other hand if we are with the crowd and even if our strategy goes wrong nobody will laugh as everybody would have gone wrong.

Finally ending with one more quote from Benjamin Graham “Individuals who cannot master their emotions are ill-suited to profit from the investment process”.

-Gaurav Mashruwala
The author is a Certified Financial Planner. He may be reached at gmashruwala@gmail.com