Buy, sell or hold stocks – how to handle volatility?

 

 

History is so important.

It has been said that the three most important words in the English language are,

“remember, remember, remember.”

: Carl Richards

 

History may not repeat but it rhymes. In early March in the middle of the first COVID wave, we were inundated with questions, mostly from Mutual Fund holders on what should investors do? Fast forward a few months, as equity volatility is on the rise again, we are getting the same question but this time from direct stock investors.

 

A lot of new investors have been led to believe stock investing is easy, finding the right stock is easy and that once you invest the returns will automatically follow.  Furthermore, a narrative has been created that while most Mutual Fund SIPs have not returned much in the last 3 years, if you were invested directly in stocks you could make a lot of money. While the first part of the statement is true, a Nifty index Mutual Fund SIP over the past three years would give you a ~4% XIRR, the second part is patently false.

 

Comparing point to point returns of stocks with SIP returns of Mutual Funds is meaningless.  To make a fair comparison, we looked at individual stock SIPs of ~275 largest stocks over the past 3 years. The average XIRR for a stock SIP is -0.9%. On average, in a stock SIP over the last three years, you would have lost money. 

 

Let that sink in!

 

 

Only 90 stocks delivered an XIRR above 4%, i.e returned better than a simple Nifty Index Mutual Fund while a whopping 162 stock SIPs would have actually lost you money.

 

With hindsight, it is easy to say ‘I would have picked 5-10 of those 90 stocks.’ In reality, it is as hard as running a 3-year gold SIP which would have an XIRR of over 20% today or a 3-year US fund SIP which would have an XIRR of ~18 – 22% today.

 

We have roughly 200 – 250 Equity Mutual Funds and ETFs in the Indian market today.  How many investors do you think were able to successfully select the high performing ones 3 years ago?

 

 

Anup who is the Chief Investment Officer at IIFL AMC recently shared an anecdote from his time at DSP Mutual Funds. When DSP mutual fund completed 20 years of the DSP Equity fund they wanted to send a thank-you note to all the investors who had been with them on the journey. The fund at that time had handily beaten the index over the 20-year time horizon. When they ran the numbers they found only a handful (less than 20 is what Anup tells me) investors stuck with the fund for 20 years. Most investors never got the benefit of the fund outperformance.

 

Long term readers of our newsletter will recognize this as the behaviour gap – something we have written extensively on. The behaviour gap is the difference between “the rate of return an investment would earn in a fixed period, and the return an investor, in reality, earns from that very investment.” This is caused by the inability of the investor to time the market. Simply put, investors buy after good returns and sell after bad returns.

 

Research has repeatedly shown that behaviour gap is higher for high volatility investments. Big rallies and falls, which are common in individual stocks, re-enforce the profit-taking and get out before the stock goes to zero feelings. Investors hold higher volatility investments for lower durations than low volatility investments. Combine this with high bid-offer spreads in stocks and also short term and long term capital gains taxes due to churning and it becomes really hard for stock investors to actually have better outcomes than a humble index fund.

 

Coming back to what should an investor do? For one, realize stock picking is hard and don’t get carried away by false hopes and promises. If you don’t have a sustainable advantage in stock picking – behavioural, informational or procedural, then don’t do it.  Follow the basics – good asset allocation driven by goal planing.

 

As to what we wrote in early March,  my favourite two are:

 

Postpone all decisions by 2 days. Say you are itching to buy or sell or stop a SIP or increase your SIP. Write the decision down and revisit it in two days. You will make better decisions.

 

If you have really itchy hands, buy Rs 100 in any index fund. Always buy, always make it a trivial amount. This is my personal favourite. It satisfies my urge to take action without making any difference to my long term outcomes.

 

A good day to revisit our podcast with Anupam at Paisa Vaisa on possible investor’s edges that can help them earn outsized gains.

 

 

Interested in how we think about the markets?

Read more: Zen And The Art Of Investing

 

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2 Responses

  • Abhijeet

    September 29, 2020 AT 05:31

    Thank you, Gaurav. These blogs remind us to remain humble in our investing decisions. There is no point in being arrogant as to our perceived ability to make perfect choices in selecting funds or stocks, entries or exits.
    “Nobody wants to get rich slow.”


    • Gaurav Rastogi

      October 5, 2020 AT 03:41

      True Abhijeet.