Stocks + Asset Allocation

It has been over a year since the 'Janata Curfew' of March 22, 2020, which paved the way a few days later for the full-fledged lockdown from which we have still not recovered fully. Except, of course, the equity markets. One of the strangest phenomena of the last 12 months has been the course of the equity markets. Back in March 2020, I was actually looking forward to a prolonged period when I could pick and choose great stocks and buy them at exceedingly attractive valuations. However, as it turned out, that period was surprisingly brief.

In fact, the reverse happened. Businesses did badly and most haven't recovered completely, while for many of them, the stock prices have touched amazing highs. It's the kind of time that has been a strong learning moment for those who like to draw obvious conclusions about the likely movements of the markets. 'Crisis => Bear Market' turned out to be too simplistic an equation for real life.

During this year, we have had a low point in the equity markets, when most stock prices were roughly half of the current highs of the markets. Such a quick roller coaster of prices also creates a similar roller coaster of emotions in the minds of savers. As prices have marched towards new highs, investors have started asking whether they should stay out of the markets and wait for a low to re-enter it. This concept, 'waiting for a correction', along with its close relative 'booking profits' is the source of much trouble for investors.

Curiously, more knowledgeable and more involved investors face these dilemmas a lot more often than those who invest more casually. The reason is those of us who are active and involved in our investments always have an urge to do something. Such investors generally do well because they learn, analyse and act more than others. Therefore, they start equating being good investors with doing something, often anything. Unfortunately, along with everything else, in practice, this also translates into reading too much into this high or that low and trying to act upon all of them.

In a sense, this is justifiable. To the equity investor who is dedicated to buying stocks at a good value, there is nothing so worrying as markets at or near all-time highs. Somewhat unexpectedly, the last few months have turned out to be a period with a great concentration of all-time highs. Therefore, to some extent, the investor's shock and awe is justifiable. There's a whole new generation of investors who have not seen such a surge as we have had and many older investors have forgotten that such things used to happen.

The problem with markets being near or at all-time highs is that the reflex action of investors is to not invest. After all, the central goal of all investing is to buy low and sell high, so why should one buy when stock prices are at an all-time high?

This reflex ignores the fact that in the phrase 'all-time high', we are making a comparison to the past whereas in the phrase 'buy low, sell high', we are making a comparison to the future. Today's high can very well be a low of the future, and indeed it has always been so. You could wait and keep waiting for a couple of years while stock prices gain another big chunk beyond this.

Still, it is reasonable to be scared of investing when the markets are high, but the solution to that is not to wait it out but something else. There are two parts of this solution:

The first part is the oldest principle in investing, which is asset allocation. No matter how committed you are as an equity investor, you simply must allocate a decent chunk of your total financial investments to safe, fixed-income investments. This must be large enough to be a meaningful buffer against volatility in the equity part. How large? Here's the answer: Some months ago, I saw a funny bit (bit.ly/jerry-helmet) from a Jerry Seinfeld comedy show that demonstrated this very point. Here's what he said, "Sky diving was definitely the scariest thing that I've ever done. Let me ask this question from the people who do sky-diving. What is the point of the helmet in sky-diving? So, if you dive from the plane and the parachute does not open, how exactly does the helmet help?" Your fixed-income asset allocation must not be just the helmet, it must be the parachute.

The second part is the second-oldest principle in investing, which is that you must diversify. Along with that comes the idea of quality. There will be ups and downs but over some years, if you have well-chosen stocks and at least 10-15 of them in good proportion, then you will win. Nothing more is required. Once you have taken care of these basics, success can't avoid you.

And how are you to do this? That's the easiest question to answer. Just head over to www.valueresearchstocks.com and your quality diversification problems are over.