Because they get influenced by the “Group Think”, rumors and unsubstantiated advice
With Indian capital markets nearing all time high, the euphoria around equity is on the verge of sweeping the retail investors into the equity market. While equity investment is an extremely powerful tool for long term wealth creation, historically, retail investors have been losing money in the stocks. Failure to properly apply themselves, while investing in stocks is the primary reason for such dismal performance.
Charles Mackay in his 1852 Classic “Extraordinary Popular Delusions and the Madness of Crowds” laid down the reasons why historically retail investors have 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 sometime be the outcome that no single member of the group would support. Thus, whether it was the Mississippi scheme or the South Sea Bubble or Tulip Mania bubbles, “Group Think” coupled with greed played havoc with retail investors in the past centuries in the western world.
Closer home in the Indian capital market, historically retail investors have been losing money in spite of the markets giving consistently good returns over the years. Unfortunately, retail investors 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 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, mostly they get influenced by the “Group Think”, rumors and unsubstantiated advice from their acquaintances.
Having made the error of entering the stocks at an elevated valuation, the retail investor once again makes the grave error when the price of the stocks starts correcting. He starts panicking and gets out of the stock by booking loss. Since he never had the conviction and was only driven by “Group Think”, he panics quickly and exits the stocks.
One of the greatest contrarians of the modern age is Anthony Bolton, who built Fidelity’s Special Situations Fund into a £ 3 billion juggernaut while it was under his stewardship. However, he’s not a superstar ‘Gordon Gekko’ trader. His cautious and sustained growth strategy led to a 14,700% rise in value over thirty years for the fund 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 adds the advice that even if you follow the crowd, you don’t have to follow them out of it if – or when – a bear market comes along. That would often be compounding the error. When everyone runs for the hills, 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’re 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 GDP growth of anywhere between 7 – 9%, the equity market is undoubtedly the place for investors to build their wealth. Assuming a GDP growth of 8% and inflation of around 6%, we are looking at a nominal growth of the economy of around 14%. Thus, an investor can potentially earn 14% plus return from his investment in equity, if he is disciplined. Also, the long term equity investment being tax free, this return is post tax. No other asset class can provide such returns under the present conditions. However, the investor needs to be disciplined.
For retail investors to benefit in the market, there is a great necessity for either doing detailed research before buying stocks or seeking appropriate advice before doing so. Having purchased stocks, the investor needs to be patient and not panic at short term temporary fluctuations. For a long term investor, the focus needs to be on the fundamentals of the market, the specific industry and the stock he owns.
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