Caution pays, overcautiousness doesn't

INVESTING

Here is a tale of two men - Tony and his subordinate, Venky. Both lost huge sums of money trying to make some quick bucks in stocks.

Their first round of losses came in after they picked up the primary issues that hit the markets in 1992. After the crash, most of the stocks they picked vanished from the bourses. Many of them were hardly traded and some were thinly traded and quoted at abysmally low prices.

The second time they gathered courage was during the technology boom. Both Tony and Venky picked up units of tech funds floated then, only to find that these funds crashed in value after the market went into a tailspin in February 2000. The net asset values (NAVs) of their units crashed only to add to their junk holdings.

Given these troublesome experiences, it wasn't easy for either of them to trust anything to do with equities.

After a lull of three years, stock market murmurs once again wooed Tony and Venky. Twice bitten Tony and Venky were four times more shy and decided not to get swayed by the markets when they heard whispers about stocks surging again in mid-2003.

But both knew it was different this time. The market fundamentals were in place, and as experts were screaming at the top of their voice, valuations were lying low making stocks really cheap (read safe) to buy. Tony resisted for two months, but relented, convinced by the arguments put forth by his financial advisor.

He bought units of two equity mutual funds and allocated about 70 per cent of his money in an aggressive equity fund and about 30 per cent in a large-cap diversified fund.

Venky, on the contrary, decided to stick to his conviction. The market have no reason to rise now, all these factors have been in place for a long, long time, he thought. Even more, boss could afford to loose, but I can't, he thought.

Eight months have passed and now, Venky is regretting his decision not to invest then, but is busy scouting for value buys now. Tony is overwhelmed looking at the returns his mutual funds have generated, but is wondering if these returns are for real. He greatest challenge now is to protect his profits.

Last year, stocks had a remarkable run. From the lows in May 2003, the Sensex almost doubled and closed the calendar with a return of 72 per cent. Naturally, equity funds also gave spectacular returns, most of them gave returns in excess of 100 per cent.

The moral of the story is: it pays to be cautious, but too much caution can work to ones own disadvantage. The fact is that stock markets take 90 per cent time to make up their minds and just 10 per cent time to get there.

So it is important to be invested at the right time. The easier way, however, is to stay invested at all times because one really can't predict with precision when stocks could rise and when they could fall.

So should Tony stay invested still? Yes, but he should do it in a way that protects his profits as well. While financial advisors normally tell you to put in money in equities with a long term perspective, what they leave unsaid is that you should encash your profits periodically. Because stock markets do not move in a linear and secular fashion. They are fickle and go through roller coaster rides.

Thus, Tony should now pull out all the profits that he has made in the market, while leaving his capital invested in mutual fund units. This way, he can continue to gain from an upmove in the market if it happens even as he would have realised all the profit.

The grand moral of the story, however, is: The boss is always right, and it pays to follow the boss!