“All men’s miseries derive from not being able to sit in a quiet room alone.” ~ Blaise Pascal
One of the many investing mistakes I made during the early part of my investing career was to be rash with cash.
Any extra cash I ever had was immediately invested in the stock market. Cash in bank was considered a wasted opportunity and every chance to “let-me-buy-stocks-now” was grabbed upon.
In the pre-2008 period, I invested a lot of the cash while keeping my eye on stock prices that were rising incessantly.
I see a lot of investors making a similar mistake now.
After getting frustrated by the way stock prices have performed over the past few years, any stock market rise is first disbelieved and then when prices rise further, people jump in so as to not miss out on any further rise.
This is a typical stage in a stock market cycle – disbelief followed by late acceptance, which is followed by a rush to invest in a hush – only that we are seeing this frequently off late.
Just consider the sharp surge in stock prices over the past four months. Several stocks have risen by 80-100%, and I see a lot of oohs and aahs from people who either did not buy during that period, or bought too less to make any difference to their portfolios.
Just read through the Comments in my recent post on investing mistakes in 2013, and you would understand where I’m coming from.
Now, as we move ahead in 2014, I see two big dangers these investors – who are feeling left out – face…
- Regret Aversion Bias
- Anchoring Bias
See these two charts and you would understand why I’m talking about these two specific biases.
These charts assume that you are eyeing a stock that has risen sharply in price over the past few months and what you may end up doing seeing its performance over the next few months…
Now, the real danger you face in these two situations is not in buying the stock, but in buying it just because you…
- Resent not buying it earlier and don’t want to get into the same situation again; and
- Worry that the stock may rise even further and you don’t want to regret later if it really does.
Buying a stock out of resentment or worry and irrespective of the business’s intrinsic value is the real danger at all times, but more so in the current times when you may be suffering from an overdose of resentment and worry.
How to Lose Big Money in Investing
Charlie Munger once quoted Jesse Livermore as saying, “the big money (in investing) is not in the buying and selling but in the waiting”.
Inverting this, we get – “The big money (in investing) is lost not in waiting but in buying and selling.”
Hyper-activity is a big killer of investment returns. The business of constantly being in search of new stocks, reading daily news events and watching stock prices move around every day can create the feeling that you should take action more frequently than is warranted.
On the other hand, patience is a fundamental principle in achieving investment success.
It is important to have determined in advance exactly what companies you are interested in owning (by creating a watchlist of quality stocks) and exactly what price would get your attention.
Then you wait and you watch.
Wait for the Fat Pitch
Charlie Munger says…
We have this investment discipline of waiting for a fat pitch. If I was offered the chance to go into business where people would measure me against benchmarks, force me to be fully invested, crawl around looking over my shoulder, etc., I would hate it. I would regard it as putting me into shackles.
Doing nothing – and holding on to cash – is a very hard thing for most people to do. People for some reason think there is a bonus of some sort for activity in investing when there most certainly is not.
In fact, there is a penalty on being overactive due to costs and expenses (trading commissions etc.).
That is what you must try to avoid – being overactive.
Set Klarman writes this in his paper – The Painful Decision to Hold Cash…
Few (investors) are able to look past near-term returns, and today anything appears to offer better returns than cash. Also, given their relative-performance-oriented, competitive nature, investors loathe the possibility of underperformance that comes from sitting on the sidelines; they find it better to be in the game (unless, of course, the market drops).
Most significantly, they remain highly skewed toward the greed end (how much can you make?) and away from the fear end (how much can you lose?) of the spectrum of investor emotions.
Betting that the markets never revert to historical norms, that we are in a new era of higher securities prices and lower returns, involves the risk of significant capital impairment. Betting that prices will fall at some point involves opportunity cost of uncertain amount. By holding expensive securities with low prospective returns, people choose to risk actual loss. We prefer the risk of lost opportunity to that of lost capital…
On the argument of whether an investor must hold cash or remain fully invested at all times, Klarman writes…
Some argue that holding significant cash is gambling, that being less than fully invested is akin to market timing. But isn’t a yes or no decision the crucial one in investing? Where does it say that investing means always buying something, even the best of a bad lot? An investor who can’t or won’t say no forgoes perhaps the most valuable tool available to investors.
Charlie Munger, Warren Buffett’s long-time partner, has counseled investors, “Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favor.”
Finally, to paraphrase Warren Buffett, ‘investing is like baseball; you are at bat waiting for a fat pitch that is in your sweet spot except in investing there are an unlimited number of pitches and no called strikes’.
The ability to do nothing and let the tough decisions go by is an intelligent investor’s advantage.
If you don’t have that ability – to do nothing and sit on cash when you don’t find opportunities – be ready to lose big money in 2014…and beyond.
P.S. On the question of where to park cash while waiting for opportunities, I do it in liquid/cash management funds, which offer me better interest rates (8-9%) than bank deposits (2-3%). Plus, when you keep cash in bank, you tend to waste it away.
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Very timely post..thanks Vishal. How many times we have heard that to win we must first finish the race and we will last the entire race only by being selective. We can indeed gain by doing nothing is such an alien concept that most of us will not be able to grasp this concept even after repeated painful lessons. Not to mention that investment world is probably the only sphere where concept gains such importance.
Thanks Arun! As Buffett says – “Lethargy, bordering on sloth should remain the cornerstone of an investment style.” Regards.
Thanks Vishal for great post. But as I find out this lethargy is the key of the stock market.
Most of people never enjoy when they are alone, silent. Being lethargic is the key but this stock market will lose its benefits if people start learning these psychological disadvantages or hurdles which i find will never be possible. Never Ever
Hi Vishal,
Thanks Vishal. The restlessness to act in such a situation is an overwhelming one. Sitting tight is a tough act to follow. Thanks again for highlighting the wisdom of patience and inaction when a situation warrants it. For a beginner like me, I cannot thank you enough. You have a lovely year. Thanks for everything.
Santosh
Thanks for your kind words Santosh! I just wish more people were to follow this act of not acting at all times.
Wish you good times ahead. Regards.
As always great piece of advise Vishal. Sorry for asking very basic question – by liquid/cash management fund which funds do we have as an option ? May I request few liquid/cash management fund example please ?
Thanks Vanita! I personally park my funds in two schemes:
1. HDFC Cash Management Fund – Treasury Advantage Plan – Retail Plan – Weekly Dividend
2. Quantum Liquid Fund
Regards,
Vishal
Thanks Vishal for sharing the couple of examples.
I agree.
I squandered away two great opportunities. In 2008, prior to the crash, I had too much of money invested in the markets. Had I removed at least 10% (considering the ‘quality’ of stocks I had back then, 25-30% would be a good number), I would have remained far more comfortable during the crash. In 2010, I had sold a lot and was sitting on cash. But since the scar of 2008 hadn’t healed, I was afraid to invest any further. I had way too much money in SB account and spent it away over the next 2 years (Just to put a number to my stupidity, I have 80% less cash now).
From last year, I have started segregating ‘investment funds’ and ‘expense funds’. Since I know that I am the worst danger to my finances, I typically channel investment funds into liquid funds. Even with ‘expense funds’, I am putting them away in tiny short term deposits which mature in time for meeting a specific set of expenses (or) liquid funds with SWP, if an expense would be spread over a period of time. I only keep what is necessary for 6-9 months expense across my bank accounts.
Coming to the dilemma of sitting on cash, it is really, really hard not to go with the flow. I am trying to attack the problem from a slightly different angle. Instead of focusing on ‘investing’ more into markets, I have turned focus towards increasing the ‘cash portion’ of my portfolio. I love chasing targets and it keeps me focused. It may work out well or I would look like a village idiot at the end of couple of years (selling instead of buying). But then, it won’t be the first or the last time I would be wrong. So, that’s par for the course.
PS: One can also look at Principal Retail Money Manager -Direct. It has been my liquid fund of choice over the last year or so.
Thanks Eswar! We are never sure what lies ahead. We can only prepare now, assuming a certain future, and that’s exactly what you have done. So, all the best!
Hi Vishal,
Great post with quotes from Klarman.
Why you say – ” You keep cash in bank, you tend to waste it away”?
You spend it thinking this is “extra” cash. 🙂
Hi Vishal,
1) So what %age of your portfolio you keep in cash?
2) Imagine you have a stock on which you are bullish for next 5 yrs. You expect it to grow at 20-30% CAGR over this period. Will you sell it at some PE? If yes, what PE? How will you arrive at the price/ pe/ pb when you sell that stock?
Jatin…
1) It depends on the situation and whether I can find opportunities. But the max I have gone at any time over the past 5-6 years is 30%.
2) It depends on the situation. I have laid down my reasons to sell a stock here – https://www.safalniveshak.com/10-point-checklist-to-sell-stocks/
Regards,
Vishal
Agree with you Vishal, there is a natural tendency to splurge whenever cash is in pocket – on stocks or otherwise. Any good investment should be independent of what number Sensex is at. I have written a small write up on how to park short term money here.
Thanks
Thanks Vivek!
I wholeheartedly agree. If whole market is overpriced, best is to sit on cash and chill out. No point buying a rabid dog just because it is least rabid. Problem is that not too many people wanted to invest on March 9th 2009. Most wanted to invest on Jan 8th, 2008. The good news is that we seem closer to the former than the latter. Lets hope for the best.
Thanks Abhijeet!
Hi Vishal,
Thanks for another wonderful post. I have been using the same strategy but instead of investing in FMP’s and liquid funds, I normally go for auto sweep FDR’s where you can withdraw as and when desired and remaining amount stills get the FD rate (to be specific, I use Money multiplier account in ICICI bank).
Is there any big difference in return on using liquid funds as compared to these FD’s ( normal rate as of now on these FD’s is 9% for 1 year although taxable).
Regards,
Anand
Thanks Anand!
As far as I know, there isn’t much difference between an FD and a liquid fund ROI and tax treatment. Regards.
Dear Vishal,
By being away from the crazy competition, I many times feel like an idiot attempting to be wise! Time will tell, although I’d probably be close to “end-of-life” before I know if I was wise or an idiot! 😉
It helps to be in Bangalore, rather than Mumbai, where there is likely to be more conversation around the market and its direction. It also helps to watch Arnab Goswami’s debates, if only to keep the mind away from the markets! 😉
-Rajaram
Yes Rajaram, we would surely focus on our balance sheets near the “end-of-life” stage. Till then, it’s just about the P&L account! 🙂
Also, I agree that staying far away from a city like Mumbai helps in behaving well as an investor. This is something I remind people in all my Workshops I conduct outside this city. Regards.
Dear Vishal,
Since 6+ months I joined your mailing list. I am very new into sharemarket. It has been a very fruitful reading and learning about markets, personal beahviour. Thanks alot for giving all this information on value investing.
I am convinced myself to start with a sum of Rs 5 lakhs, how do I allocate it, what is the good size of allocation to any company. Between I am yet to find a good Demat account provider, which is the best in market.
Thanks alot Vishal and all the Tribesmen for sharing.
Thanks for writing in Srinivas!
Since you are new to the stock market, I would suggest you begin with a few equity mutual funds. Then, as you learn how the stock market behaves and also learn how to pick stocks on your own, invest a part of your savings on your own. But start by carefully choosing 2-3 good funds and do SIPs in them.
Hope this helps. Regards.
Thanks Vishal for suggestions
Brilliant timing and a fantastic article! Thanks a lot for taking time to write good stuff. I have been wanting to get to about 15-20% cash but procrastinating it.
While waiting for an opportunity is important, we also need to be careful about waiting for that perfect opportunity like 2008 – where throwing dart would have given 100% returns. It may not happen very soon. I wasted 2011 December wanting the Sensex to go lower and lower for a perfect opportunity but it never went low enough.
Personal Lesson Learnt: Cheap or costly should be based on the intrinsic value (future value discounted to current time) of an individual stock & not the overall market or peers or historical numbers or any such arbitrary benchmark. Every stock is an opportunity to be evaluated separately. If there are profitable opportunities, it is important to get on with it – totally disregarding Sensex number or other arbitrary benchmarks. Copying from the same Seith Karlman link – “One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities”.
Indeed Subbu…I completely take you point. Sensex is a nonsensical barometer. What matters is a company’s stock price versus its intrinsic value.
Then, when you get a fat pitch, it’s important to hit, and hit hard. Regards
I have slightly different views. i am awlays 100% invested and in fact most of the times 120%. that includes 20% loan against shares. sitting on cash is good in theory but what about the opportunity cost ? if you feel your 80% of the portfolio gives better returns than a liquid fund, what makes you think that this 20% cant do it ? its like being bullish and bearish at the same time. there are several stocks that you can park your money and still get better returns like asian paints, hdfc bank, itc etc.
since no body can predict 2008 lows or 2011 dec lows, its futile to sit on cash waiting for that great opportunity. as subbu explained its your stocks intrinsic value that matters most than the index/market returns. sometimes we lose good opportunities looking at the macros. 3 months back when nifty was at 5200, everybody predicted a crash and didnt invest. its an opportunity lost. for investors like us its a marathon, we need to keep investing systematically, give maximum exposure to your cash to get the best returns
No Bala, it’s not being bullish and bearish at the same time. It’s simply about reading with caution.
Also, as I already mentioned in my post –
…the real danger you face in these two situations is not in buying the stock, but in buying it just because you…
1. Resent not buying it earlier and don’t want to get into the same situation again; and
2. Worry that the stock may rise even further and you don’t want to regret later if it really does.
Buying a stock out of resentment or worry and irrespective of the business’s intrinsic value is the real danger at all times, but more so in the current times when you may be suffering from an overdose of resentment and worry.
Isn’t it nearly impossible to not have a single opportunity at any point of time….we can put money there..
Shreyansh, opportunities are always there. The idea is to find them. You must however be careful whether an opportunity is real or it is just wearing the garb of rising stock price.
one of the things i follow is ..after i make up my mind of any stock i wait of 10 days if i’m still interested in it..i buy if not then leave…and i read this somewhere in your blog itself..so thank you vishal sir..
Good to know that Shreyansh! 🙂
thanks lot for such an beautiful article
Thanks for your comment, Mahesh!
Hello Vishal , While exploring I came across another genere of fund – debt fund. Could you please help me understand the reason we should park our extra money for short term in liquid fund and not debt fund ?
Dear Vishal, You are doing a great service to educate the common man on investing and stock market especially for people like me who come from middle class family in a small town. I am one of those who invested mindlessly and lost a lot of money. I wish we had someone like you to guide us at the start of our career.
Having said that I am glad I learnt the lessons and decided to become more sensible, learn more and not influenced by what others say.
I am grateful for what I have. I have registered for workshop at Chennai. Looking forward to attend and listen to you in person.
Thanks
Bala
This one line says it so well ‘We prefer the risk of lost opportunity to that of lost capital…’