The first shock in an equity investor's life is a big turning point that decides which way the future will go
09-Mar-2020 •Dhirendra Kumar
Do investors ever change the way they think about equity-based investments? When I put it like that, a lot of you would be tempted to say that no, people never change. Most of us fall into certain patterns of thinking during our formative years and never really change. I don't believe that. In fact, that's a somewhat depressing idea because it's just a different way of saying that people don't learn and that if they are doing something wrong, they'll just go on doing that all their lives.
This is just not true. SOME people may not learn, but most people do. I don't mean this as a general rule of life - that's not my brief here - but as a rule of investing. All successful investors start out in their investing life believing some things are actually not true. Some of those things are true in a particular phase of the equity markets. You could start investing at a time when it's easy to make money on many stocks and on almost any equity fund.
This has actually happened to many of us over the last three decades. There have been many, many easy times. Somehow, despite knowing that the good times cannot really last, you sort of believe that old myth that 'this time, it's different.' Except that it isn't. The going gets tough. 1995 or 2001 or 2008 happens. (Not to worry, I won't add 2020 to that list. Not yet, anyhow.) Now, to match the external phase change, you need a mental phase change. The change that actually happens could be positive, could be negative. You could just give up and run away. A five or 10 per cent decline in the value of your investments happens frequently enough for investors to get used to it as part of the normal sequence of events. Moreover, if you have been investing for any length of time, what you are likely losing is one part of your gains. It's not that big a deal. No shift of mental gears is needed to absorb the shock.
However, when half or more of your investments vanish, as happens sooner or later, the shock is severe. At that point, many investors abandon equity-based investing and run away from investing. I've seen it time and again over these decades. However, a handful make the mental phase change. For a variety of reasons, some people do it. These reasons are interesting. Generally, the most common is that the investor has been at it for a long time, has invested gradually, and has a reasonable amount of diversification across asset classes. Moreover, the investor is aware of all this. He's not just going by thumb-rules and vague estimates but knows what he is earning and how. The result is that even in the worst declines, the investor knows that the moorings of his personal financial situation have not come loose.
It doesn't take too much time at the bottom to figure out that market declines have hidden benefits if you understand what's happening and it's simple and easy to take advantage of it to build the foundation for future gains.
When the next big crisis hits, investors like this are licking their lips, hunting for bargains that will make big gains in the future. It gets easier - and more profitable - every time. Essentially, market declines are a Darwinian moment. Those who can evolve mentally get fitter and fitter to create wealth from their investments. Those who can't get past that first shock get winnowed out of the gene pool of equity investors.
As the world enters a phase of unpredictability, the choice is yours.