October 22, 2007

How to look at the market swings - Time horizon

I have been re-thinking my time horizon for investments for some time and have made some changes to it. The corresponding impact on my investment decisions and how I look at the market swings has been dramatic. My earlier time horizon was on an average 2-3 years. However I have now increased my time horizon to 10 years for my SIP component. The active portfolio component still has a horizon of 2-3 years.

I cannot understate the impact of extending or changing time horizon has on how one looks at market volatility, current events, investment ideas etc. Let me illustrate

10 year or more horizon – If you are in you 20’s, 30’s or even 40’s this time horizon makes sense. For a time horizon of 10 years, short term market movements have no importance. Over a 10 year horizon, if you are looking at index funds or well managed mutual funds, a small amount of overvaluation does not matter. These overvaluations would even out as long as one has not bought extensively during the peak. At the same time if you are investing via SIP (systematic investment plan), then during a 10 year or more period, there will be periods of recessions, market bubbles and all kinds of fluctuations. However the portfolio should perform well (see my post on the power of SIP

If like me, you are investing a portion of your portfolio with the above horizon, the current circus on PN notes, subprime crisis in US, oil price etc etc will not hold too much importance. If you feel that Indian companies as a whole will do well in the next 10-15 years, then find an ETF, get into an SIP and get on with other things in life

2-5 years – This is my active portfolio horizon. I tend to look for undervalued companies selling at 50% discount to intrinsic value and if the gap closes in 2-3 years, I have a 20-25% return per annum. For this horizon, current market events make a difference in the sense they provide me opportunities to buy stocks which have been beaten down for no reason. The more the better. Beyond that, it doesn’t matter whether the market will open 1% up or 1% down.

1 year or less – This is the time horizon for the aribitrage component of my portfolio. I have written about a few likely opportunities earlier. Here some corporate action such as buy back, rights issue, spin offs create an opportunity. In this component, current market level or events should not matter. The company specific developments are more important. However I have seen that sometimes market events can suddenly throw off the entire calculations and result in a loss. I am still not heavily into arbitrage and would not have more than 10% of my portfolio in it in the future.

1 day – 1 month – I do not operate in this horizon. Profitable or not, it is not my cup of tea and I do not have the stomach for it. This where all financial websites, TV channels’ and several blogs focus. In this time horizon the current PN issue, subprime in US and whether the market will open higher or lower on Monday may matter. Question to ask yourself – are the returns you are making commensurate with the effort?

All I can say is that if you decide to play this game, have the stomach for it and don’t risk too much capital.

I have been reading on some websites and blogs, stories of people who got into the market near the top and are now suffering losses. I can empathise with them as I have gone through the same. The problem is that most of us think we can tolerate losses, but when they really happen it is gut wrenching. The worst thing to happen is that such people get scared from the market for ever and never return back. That is definitely not good in the long term if you want to build a decent nest egg.

I think it is important for us to understand our risk tolerance and see which time horizon we want to operate in and take investment decisions accordingly. That ofcourse is easier said than done.


venkat said...

Dear Rohit,

Need your inputs.

Company A has issued FCCBs which are converted at a price let's say Rs.3000 per share (face value Rs.10). The present market price is Rs.200 (face value Rs.2).

Does this mean the promoters were expecting the share price to reach Rs.600 per share (Rs.3000/5) in the first place.

Gaurav said...

Hi Rohit,

I was looking at Sundaram Finance and came across your post on Google search. Can you provide a detailed SOTP analysis of the company. Much appreciate your help.. Regards, Gaurav

Ranjit kumar said...

Hi Rohit,

To add one should not go into futures and Options if one has no stomach for loosing big. We think that a rupee or two increase/decrease in the premium of an option can fetch you few thousand rupees, but on the downside it will rip you.

Ranjit kumar

Rohit Chauhan said...

venkat - yes ..you are right. that is the strike price for FCCB. If i remember correctly FCCB has a fixed income portion and a warrant portion which converts to equity at a strike price

gaurav - i have a detailed worksheet which i will post into google groups soon

ranjit - i agree with you. i think per se options or futures are not good or bad. it is just that because they are leveraged, the risk is very high. so people who dabble in them without understanding them fully lose over time. i know of friends who think options is easy money, have made some money for a time and then have given it back in a single trade.

Anonymous said...

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Anonymous said...

Hello Rohit,

In 2005 i passed from my engineering course and joined a software MNC.As there was too much hype about stock markets i too got lured into it and had my Demat account.

Confused why i am writing this story,please read on.The next part was to do some investing and for that i wanted to earn big and fast.My first trade was buying Reliance pre split at 830/- a share.Many said it was overvalued and i wont gain from split.I had other thoughts,i have always had a fascination for reliance and i thought i was perfectly right.In fact i was and today that 830/- has zoomed to 5000/-.

The next thing i heard was value investing.And i hate the day i heard about this whole value investing funda.I started to read blogs of value investors and plz dont take otherwise they are so sick people that right from 8000 level of sensex they are saying that the market is overvalued and market will crash and only value investors will have the final say.Today market stands tall at 17500 and value investors are as usual worried.

And after devoting so much time to value investing i feel i have missed the bus from 8000 to 17500 in a big way.Guys who had simply invested in sensex (famous) stocks have made much much more than what i have made.

May be all this value investing will come handy when the market actually crashes and go in a bear phase.Seems that is not going to happen anytime sooner.

I m sorry for myself and for most value investors i guess.Most have lost.....agree or disagree i hold my view.........

Amit agarwal.

Rohit Chauhan said...

hi mohit

send me your email. i will send my feedback to your email