A Common Man's View of Stock Market Investments
Most stock markets have peaked across the world with valuations looking very expensive. A correction looks imminent for markets across the globe. The correction could be about fifteen percent from the peak levels or even as bad as fifty percent. It is not easy to predict how much the markets will go down when they start going down.
But what goes up must come down. The markets have gone up for too long. Easy money policies by central bankers around the globe has resulted in the long bull run. Easy money cannot, should not, and will not continue for long.
With many central banks tightening the screws on liquidity, stock markets will give away some or most of the gains. Greed and fear are the two stages in the investment cycle resulting in a boom or a market crash. It is my personal view that the markets are due for correction across the world. I am not a stock market expert and I am just sharing my views as a common man.
Stay with Cash
Cash is King
It is prudent for most individual investors to move bulk of their investments to cash, deposits and safe Government bonds for now. I am not saying one should sell every stock. One can retain quality stocks with strong fundamentals and sell only the others.
Deposits or Government bonds may not give attractive returns but these do not go down when the rest of the markets do.
I am afraid the corrections will not be limited to stocks alone this time. The easy money policy has inflated asset prices across commodities, real estate and other asset classes.
So we may see some pain in sectors such as commodities and real estate too. Digital currencies are also susceptible to some serious damage.
Identify Hidden Gems
This is also the time to identify good value picks among stocks. I believe in following the old school thought of looking at fundamentals. We need to look at price earnings ratio, revenue growth, earnings growth, dividend yield and dividend growth of a stock to decide if a stock has the potential for growth. Most of these metrics are available at the click of a button now. We should also analyze the company's historic performance for the last five years to assess the trends.
We should never listen to advice from financial experts blindly. An expert may recommend, for example, buying a company because it would do well in a low interest rate regime. But if the low interest rate regime comes to an end in two months, the expert advice that was given earlier would not be valid anymore. So we should follow expert advice only when we understand the reasons behind their advice.
What if one is not interested in all the number crunching involved? Ideally, such a person should stay away from direct exposure to stocks but can invest through the mutual fund route. But even for a person investing in mutual funds, some basic understanding is needed to appreciate the differences between an index fund, a sector fund or a growth fund.
Once the hidden gems are identified, wait for the market to bottom out before buying. This is easier said than done. No one knows for sure where the bottom lies. It could be 25% below the peak, 50% below the peak or even worse.
This is a judgement one needs to make on their own. My personal expectation is that the markets could correct anywhere between 25 to 50% from their peak values across the globe. The assumptions driving such a prediction are tight monetary conditions, excess valuations and increasing interest rates. However, it is tough to predict markets. One should take the views of a non-expert like me with a bagful of salt. However, one can take efforts to understand the markets and form their own judgements on market directions.
One practical approach is to start buying when the market corrects by about 10% from the peak. We can divide our planned investments into twenty equal parts and one part can be invested every month for the next twenty months. This way, we can average out the market fluctuations and hence minimize risk. We can use the market correction as an opportune moment to buy.
Stock market is an attractive investment option if and only if an individual is prepared to put in the effort to understand the markets. This could involve detailed analysis of the sectors and the companies one is interested in investing in.
Everything Takes Time
A mango tree takes about eight years to bear fruit. Stock market investments take about the same time to bear fruit in the form of dividends and capital appreciation.
Stay Invested for the Long Term
The recipe to success is staying invested in stock markets for long. It is difficult not to sell a stock that has gone up by 25% within a few months. It looks like a great return to make in a short period of time. But it is possible that this stock has the potential to go up in value by ten times or more in the next few years.
Most stocks give attractive returns only when we stay invested for long. It is tempting to make a huge profit in a short time. But success does not come fast. A mango tree takes about eight years to bear fruit. Stock market investments take about the same time to bear fruit in the form of dividends and capital appreciation.
I have learned this the hard way by making small returns and even losing money with a short-term approach. But I have managed to make very good returns whenever I have invested in mutual funds or stocks over a longer period of time.
Experts like Warren Buffet and Rakesh Jhunjhunwala have always advocated the importance of staying invested for long. The compound annual returns from the stock markets could be as high as 20% but only if we stay invested in the long run.
I never really understood the markets well earlier and so I used to invest only a very small portion of my savings there. Now that my understanding is getting better, I am slowly increasing my exposure to stock markets. Happy investing!