Chasing yields

When we are in a peculiar situation when the interest rates are below price inflation rate and equity markets have remained at low levels for long, people start to chase yields.

When investments in fixed income securities are not earning to cover price inflation or the growth in expenses, investors have no option but to take on certain risks.

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The real value of history in the world of investing

William Bernstein writes in his classic Four Pillars of Investing – Lessons for building a winning portfolio: “The real value of the historical record is as a gauge of risk, not return.”

Still, majority of discussions focus on which asset class has outperformed or underperformed which other asset class. The focus is too much on the returns generated rather that the risks taken or avoided.

Read history to understand the risks. Read history to understand what can go wrong. Read history to understand what you can do to protect and nurture your investment portfolios.

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The risk of not diversifying

Few days ago, we explained the need for diversification: read the post here.

Now add to that three important points:

  1. The fall in the value of a concentrated portfolio as compared to a diversified one, and
  2. The investor behaviour of chasing the recent past performance
  3. At any point in time, at least one part of a diversified portfolio would outperform the diversified portfolio itself

These three statements mean a huge risk for most investors. Let us elaborate. First of all, at any point of time, the diversified portfolio would underperform at least one part of its own. In a bull market, especially, one sector would be leading the rally. This sector hogs the limelight. Since the performance is great, many investors invest in it only after seeing great past performance, which means most of the gains have been made and the prices have reached high levels. Buying costly is always a riskier proposition for investors as money-making opportunities are less of one buys costly. The faster rise is often followed by a steep fall. The leader in the rally is generally the leader in the fall, too.

since the investor missed out on the rally and entered at higher levels, there is disappointment for her.

Read more about some more examples in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget:

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Real v/s perceived risk

“The reason why most get it wrong in stock markets is that there is a gap between the actual risk and our perception of the same. Most of the times, the risk is at the highest when it is perceived to be at the lowest and vice versa. The risk of terrorist attack was actually the least after WTC event, but the whole of US was terrified”

Adopted from “The Mind of Wall Street” by Leon Levy

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Leverage and illiquidity

Leverage used to invest in illiquid assets poses a serious risk. Similarly, if you do not have an alternate cash flow and the asset is illiquid, repayment of borrowed money becomes difficult

You may also want to read this article.

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Why are markets taking a nasty “U” turn? – from the archives

The year 2016 has begun on a threatening note for the global stock markets with China leading the way. The current events remind one of the phrase “bull in the China shop” – just that this time it’s a bear, in the stock market lingo.

Someone sent a note suggesting the leveraged positions that retail investors had in the Chinese stock market.

Here is one of my old articles, written in 2007 for http://www.moneycontrol.com.

Why are markets taking a nasty “U” turn?

In the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”As I have quoted Bishop Desmond Tutu: “What we learn from history is that we don’t learn from history”

Enjoy reading!

#RidingTheRollerCoaster

Perception of risks

We do not perceive risks when things go right and by the time we do, it is too late

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