Why You Should Ignore Your Portfolio for Months at a Time

This is part two of a guest post series from Monevator, a personal blog that provides money tips and motivation for private investors. You can find:

• part one – Beat Market Volatility by Being Boring
• part three – Why you Should Invest When the Market is Falling

Strategy 2: Try to ignore your portfolio for months at a time

Even better than a boring account is one you don’t bother checking at all. It might seem ridiculous not to watch your portfolio like a hawk, but if seeing yournet worth fluctuate makes you unhappy and scares you out of the stock market, then checking your performance is counterproductive.

Warren Buffett famously implores investors to buy stocks for the long-term, and he’s done quite well. How long is long-term? Certainly longer than the horizons of private investors who check the prices of a stock they bought 60 minutes after assuming ownership. (Yes, that includes me! Editor’s note: Me too!)

Buffett once said, “I buy on the assumption that they could close the market the next day and not reopen it for five years”. Buffett is so confident in the businesses he buys that the daily fluctuations in their value aren’t a concern. I wouldn’t go that far – I’m not as sure of my ability as I am of Buffett’s – which is one of many reasons why I’m not as rich as him. But I can tell you that checking your portfolio every day (let alone every hour) is guaranteed to make you unhappy.

The reason is that while stocks, in aggregate, have always gone up over the truly long-term, their value can go anywhere over shorter time periods.

Nassim Taleb illustrates this really well in his excellent book, Fooled By Randomness. Assume, Taleb suggests, that you are investing in a market with 15% returns and 10% volatility per annum. This equates to a 93% probably of success in any given year. Pretty good odds, eh? Over shorter timescales, though, the picture is different.

Here are the chances of success with Taleb’s example investment over different timescales:

Scale – Probability
1 year – 93%
1 quarter – 77%
1 month – 67%
1 day – 54%
1 hour – 51.3%
1 minute – 50.17%
1 second – 50.02%

Personally, I find these figures really interesting. In the ultra short-term, even an ultimately successful investment is barely more likely to be up than down.

Now, Taleb asks us to imagine a fictitious dentist who checks the above investment every day.

At the end of every day the dentist will be emotionally drained. A minute-by-minute examination of his performance means that each day (assuming eight hours per day) he will have 241 pleasurable minutes against 239 unpleasurable ones.

Psychologists have shown that we feel pain from losses more than we feel pleasure from gains. Over the short-term, the pain of seeing losses from our stocks will outweigh the pleasure. The danger then is we sell out to stop the pain.

In contrast, if the dentist only checked his portfolio once a month, then as 67% of his months will be positive he’d have only four miserable sessions per year, versus eight good ones.

Checking yearly, he’d be even happier with his performance. Only in one year out of 20 would he drill unnecessary holes on unsuspecting patients to work off his anger. The other 19 years, he’d be thrilled.

Taleb’s specific investment is invented, but it is directly comparable to investing in the stock market. Most of us hold our investments for the long-term, yet we monitor their performance regularly over short periods of time, exposing ourselves to inevitable anguish.

Over 40 years of our investing for retirement, history suggests investors in stocks will do very well. Over a month, let alone a day, almost anything can happen.

So why worry too much along the way? If you’re not a stock market junkie, don’t become one.

Have faith, and keep up with regular investments. Check your portfolio once a year, where you might also consider rebalancing between the various asset classes such as stocks and bonds.

You’ll almost certainly end up richer than the day trader next door.

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The Basics of Fundamental Analysis

Fundamental Analysis Definition

Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.

The fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc..

General Strategy

To a fundamentalist, the market price of a stock tends to move towards it's “real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is above the current market price, the investor would purchase the stock because he knows that the stock price would rise and move towards its “intrinsic or real value”

If the intrinsic value of a stock was below the market price, the investor would sell the stock because he knows that the stock price is going to fall and come closer to its intrinsic value.

All this seems simple. Now the next obvious question is how do you find out what the intrinsic value of a company is? Once you know this, you will be able to compare this price to the market price of the company and decide whether you want to buy it (or sell it if you already own that stock).

To start finding out the intrinsic value, the fundamentalist analyzer makes an examination of the current and future overall health of the economy as a whole.

After you analyzed the overall economy, you have to analyze firm you are interested in. You should analyze factors that give the firm a competitive advantage in it’s sector such as management experience, history of performance, growth potential, low cost producer, brand name etc. Find out as much as possible about the company and their products.

Do they have any “core competency” or “fundamental strength” that puts them ahead of all the other competing firms?

What advantage do they have over their competing firms?

Do they have a strong market presence and market share?

Or do they constantly have to employ a large part of their profits and resources in marketing and finding new customers and fighting for market share?

After you understand the company & what they do, how they relate to the market and their customers, you will be in a much better position to decide whether the price of the companies stock is going to go up or down.

Having understood the basics of fundamental analysis, let us go into some more details.

When investing in the stocks, we want the price of our stock to rise. Not only do we want our stock price to rise, we want it to rise FAST! So the challenge is to figure out: which stock prices are going to rise fast?

Some stocks are cheap and some are costly. Some are worth Rs.500 and some are even worth 50paise. But the price of the stock is not important. The price of the stock does not make a stock good to buy. What is important is how much the price of the stock is likely to rise.

If you invest Rs.500 in one stock of Rs.500 and the price goes up to Rs.540 you will make Rs.40. However, if you invest Rs.500 in a 50paise stock, you will have 1000 stocks. If the price of the stock goes up from 50paise to Rs.1, then the Rs.500 you invested is now Rs.1000. You made a profit of Rs.500.

If you understand this, you can see that the price of the stock is not important. What is important is the rise in the stock’s price. More specifically the “percentage” rise in the stock price is important.

If the Rs.500 stock becomes worth Rs.540, then that is a 8% rise. This 8% rise only makes us Rs.40. On the other hand when we invest the same Rs.500 in the 50paise stock and the stock price goes up to Rs.1, it is a 100% rise as the stock price has doubled. This 100% rise makes us Rs.500.

The point is that when picking a company, we are interested in a company whose stock price will rise by a large percentage.

Please note: Looking at the above paragraphs, it may seem like a good idea to buy all the really cheap 50paise and Rs.1 stocks hoping that their price will rise by 100% or more. This sounds good, but it can also be really really bad some times! These really small stocks are very volatile and unless you know what you are doing, do NOT get into them.

However, the point to be noted is that we are interested in stocks that will have the highest % rise in the stock price. Now the question is, how do you compare stocks. How do you compare a stock worth Rs.500 to a stock worth 50paise and figure out which one will have a higher percentage rise.

How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week?

If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. There is no way to compare them!

So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do!

Next let us get into the tools and ratios that tell us about the companies and their comparison....

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Why does a company issue stocks?

Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to "raise money". To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock.

A company can borrow by taking a loan from a bank or by issuing bonds. Both methods come under "debt financing". On the other hand, issuing stock is called “equity financing”. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.

All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).

It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments.

This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.

It’s a tricky game!

Note that: There are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends. Without dividends, an investor can make money on a stock only through its appreciation of the stock price in the open market.

On the downside, any stock may go bankrupt, in which case your investment is worth nothing.

Having understood this, we now want to know what makes stock prices rise and fall? If we know this, we will know which stocks to buy. In the next section we will try to understand what makes stock prices go up and down.

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Stock Picking - Which stocks to buy?

Having understood all the basics of the stock market and the risk involved, now we will go into stock picking and how to pick the right stock. Before picking the right stock you need to do some analysis.

There are two major types of analysis:
1. Fundamental Analysis
2. Technical Analysis

Fundamental analysis is the analysis of a stock on the basis of core financial and economic analysis to predict the movement of stocks price.

On the other hand, technical analysis is the study of prices and volume, for forecasting of future stock price or financial price movements.

Simply put, fundamental analysis looks at the actual company and tries to figure out what the company price is going to be like in the future. On the other hand technical analysis look at the stocks chart, peoples buying behavior etc. to try and figure out what the stock price is going to be like in the future.

In this article we will go into the basics of “fundamental analysis”. Technical analysis is a little more complicated. It is much more of an "art" than a science. It depends more on experience and involves some statistics and mathematics, so explaining technical analysis is out of the scope of this article.

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What are the Sensex & the Nifty?

The Sensex is an "index". What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.

The Sensex is an indicator of all the major companies of the BSE.

The Nifty is an indicator of all the major companies of the NSE.

If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.

Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.

Just in case you are confused, the BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.

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3 important things you must know and follow as an new investor!

You need to KNOW some “unforgettable basics” before you enter the world of investing in stocks. The stock market is a field dominated by savvy investors who know the ins-and-outs of the market. For people who are not “on the inside”, the stock market can be a VERY dangerous place. :

Don't even consider "tips" that tell you about "hot stocks". Consider the source: There are many people in the market who put in all their time and effort in promoting certain stocks. They do this because they have their money invested in those stocks. If they can get enough people to buy the stock and they can get the stock price to rise, they will sell the stock for a huge price, the stock price will crash and they will walk off to promote another stock.

Always use your own brain: It's extremely important. You must always use your own brain. Relying on the advice of others, no matter how well intentioned it may be, is almost always a complete disaster. Make sure you dig in and really examine the "facts about the companies" before you invest. Ignore press releases which have very little substance, and rely on "hype" to tell the company's story.

And finally the most important tip!!!
Only invest money you can afford to lose!! Sure this is a basic point, but many many people miss it. You should only invest money that you can honestly afford to lose!! Everyone enters into investments with the idea of earning big profits, but in many cases, this never works. (Especially if you are new to investing in the stock market!)

Please understand that the above tips are tips for beginners. Once you really get into the stock market you do not need to follow these rules anymore. But if you are a new investor, you MUST follow these rules. They are for your own safety.

But then again, nothing comes free. Everything has a price. You will have to loose some money, make some bad decisions and then only will you really understand the market. You cannot understand the market by just looking at it from far. By following these rules, you will basically not loose too much!

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