Correct and incorrect choices

Here's an old Wall Street joke that you may or may not have heard. So the newcomer asks a grizzled veteran, "How do I make money on the stock market?" The old master replies, "Why, that's the simplest thing. Buy low, sell high." So the young man asks, "Yes, but how do I do that?" The reply comes, "That's very difficult. It takes a lifetime to learn."

It may not be a great joke, but it is absolutely true. It seems almost obvious that the most likely interpretation of 'buy low, sell high' is to buy when the markets have fallen, as they have over the last few weeks. Investors and advisors are universally of the opinion that a 'correction' (a foolish euphemism) is the right time to buy. As proof, one can look back and do all kinds of calculations showing that investors who bought when the markets had slided made more money than those who did so when the markets were high. Such calculations, of course, are a prime example of 20/20 in hindsight. When the 'correction' happens and the market becomes correct (I'm extending the euphemism), how do you know that it's not going to become even more correct? And then what happens if it becomes extremely correct? How long will you wait for it to become incorrect again? The correct answers to all these questions are crystal clear when you are in a retrospecting mode, but are more of a guesswork when you are trying to predict the future.

However, the real reason why this approach is less than ideal is different. The moment we say that we must invest because the markets are dipping, we are effectively telling ourselves to not invest in a falling market. Perhaps we should even sell our investments and wait for the decline.

That seems like a logical and sensible thing to do. Buy stocks or invest in equity mutual funds when markets fall. And if it's a good idea to buy when the markets are diving low, then the corollary is to sell when the markets are zooming up. It must also be a good idea too! Both view points seem to be exactly that will lead to higher returns, right? Superficially, it all seems to make sense.

Actually, it does not. The right thing to do is to never buy according to where you (or others) believe the market is heading. Investors need to invest according to the quality of an investment, and whether it is fairly priced according to its intrinsic characteristics, and not by making a guess work either of the investment's or the market's future momentum. More than a century of experience has shown, trying to time markets is no better than acting randomly. This is even more true in the kind of knee jerk volatility that has become common in recent years.

Professional punters may do whatever they want to, but for mutual fund investors, the path is absolutely clear. They should choose three or four equity funds with good long-term track records and invest steadily through SIPs, and not bother with market crashes. The whole point of investing in a mutual fund, either through an SIP or otherwise, is to continue doing so in bad times also. You cannot foresee the future. You also do not know when the market will correct and when it will incorrect. You do not know how suddenly any of that could happen. All that you know, with a high degree of confidence, is that sustained over years, equity investments will bring great returns along with great volatility.

The only way to use this combination of great returns and great volatility is to keep investing continuously, regularly and steadily, without interruption.