Market Sense — 049 — July 2020
The Month Gone by!
On the 28th of July the markets reached their highest closing since March 11th, 2020 when the US Markets had to be shutdown. The markets are up over 45% since the lows of March. This is at variance with the global and national economic data, which is at their worst over a long period of time. As they say markets discount the future. The market is riding high on the huge liquidity unleashed by Central banks. The positive news on the COVID Vaccines clinical trial results is acting as a strong tailwind, pushing the indices higher and higher.
In India it is said that a large chunk of the population of Delhi and Mumbai have developed immunity against the virus. However, the ground situation in not that rosy. Company after company have reported poor results except for companies in certain sectors such as digital businesses, telecom, FMCG etc.,
For the first time in four years the inflows into Equity Mutual Funds became negative during June 2020. It is suspected that many individuals have withdrawn from the market due to the uncertainty over job security and income levels.
With gains of about 9% so during July, the Sensex is set for a second monthly advance, thanks to flows from overseas funds. But mutual fund investors aren’t sharing this exuberance and seems to be extremely cautious.
Basis of Investment Returns
The whole basis of investment and financial planning is based on a simple formula taught at middle school.
The principle of interest and more importantly compound interest. From the formula it is clear that three variables control the outcome
1. Principal Amount (Investment)
2. Interest Rate (Return)
3. Number of Years (Period of Investment)
Amongst the three variables a common citizen has limited or no control the first two variables. Amount of Investment is limited by his income and expenses. The Interest rates are subject to market forces on which no one can have control except of course the Central Banks. An investor can control only the period of investment
Emotion of Instant Gratification
It is clear from the formula that longer the period higher the outcome. Quite simple. If moneymaking is so simple why are there only a few rich and wealthy people. The primarily reasons are
1. Poor Saving Habit
2. Lack of Patience or the need of Instant Gratification
It is said by many Behavioral Economists that Instant Gratification is the root cause for poor investment outcomes in many situations. People love to flaunt the latest mobile phones, love eating out at expensive restaurants, dress in expensive clothes etc., In general we bombarded by marketers are sublimely forced to part with our hard-earned money. We become victims of Instant Gratification.
Marshmallow Experiment
In the 1970s, a Stanford Professor named Walter Mischel conducted a series of psychological studies. The purpose of the study was to understand how and when, the control of delayed gratification (the ability to wait to obtain something that one wants) develops in children.
The experiment began by bringing each child into a room, seating them down on a chair, and placing a marshmallow on the table in front of them. At this point, the researcher offered a deal to the child. The researcher told the child that he was going to leave the room and that if the child did not eat the marshmallow while he was away, then they would be rewarded with a second marshmallow. However, if the child decided to eat the first one before the researcher came back, then they would not get a second marshmallow. So, the choice was simple: one treat right now or two treats later. The researcher left the room for 15 minutes.
As you can imagine, some kids jumped up and ate the first marshmallow as soon as the researcher closed the door. Others wiggled and bounced and scooted in their chairs as they tried to restrain themselves, but eventually gave in to temptation a few minutes later. And finally, a few of the children did manage to wait the entire time.
Published in 1972, this popular study became known as The Marshmallow Experiment.
Way Forward
Replace “MARSHMALLOW” with “MONEY” in the experiment and the context won’t change. The ability to delay gratification is one quality that consistently separates the most successful ones from the not so successful ones. Delayed gratification is associated with resisting a smaller but more immediate gain in order to receive a larger or more enduring reward later.
When you invest money in stock markets, you typically don’t get a linear or a fixed return like a Bank FD, the returns are volatile, however in the longer waiting period the returns tend to be far higher than Bank FD. Often investors repent selling a share quickly for sharp spike in its price, after it goes up 5–10 times or more in less than 5 years after the sale.
During rising markets, it takes a tremendous amount of patience in order to maintain the investing discipline. If you can suffer amidst the trials that Mr. Market may force upon you from time to time, you guarantee yourself an investing life peacefully lived.
Happy Investing……………