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Ravi, an investor, recently made headlines by calling into a leading business news channel with an unusual announcement – apparently, he had been gifted 20,000 shares of MRF by his grandfather. Still in physical form, these shares were worth – hold your breath – Rs. 130 crore on the day of his call!

MRF has seen a meteoric rise since 2001, when it still traded at modest Rs. 500 levels or so. In the past 16 years, it has delivered astronomical annualized returns of 35%, trading at nearly Rs. 62,000 per share today – making the purchase of even a single share out of reach of many new investors.

MRF isn’t alone – the stock exchanges are rife with stories of ‘dream run’ stocks that have consistently grown for a decade or longer. Supreme Industries, CRISIL, CERA and Bosch are just a few examples of stocks that have risen exponentially over sustained periods of time.

While equity markets offer equal opportunities to all investors, only a few really go on to create wealth form them. In fact, the majority of retail investors like Ravi often end up burning their fingers and swearing off equity markets altogether.

Here are three reasons why odds are that you won’t be repeating Ravi’s extraordinary investment performance anytime soon.

The Action Bias

Financial Assets such as stocks and mutual funds have more price transparency than physical assets like real estate. Resultantly, investors in these asset classes tend to be more watchful of their investment valuations, often staying glued to terminals or television screens for hours each day, reacting to each tick with trepidation or elation. In the long run, this tendency works against them, as they become more and more ‘active’ with their investments, believing that doing so will result in more alpha generation, better risk control, or both.

Ravi was lucky that his grandfather ‘bought and forgot’ his holding in MRF – which is probably why his shares hadn’t even been dematerialised. Had the valuation of his shares been in front of him on a terminal daily, he would have probably ended up liquidating his MRF holdings a long time ago. The investing maestro Warren Buffet once remarked: “our favourite holding period is forever”. If you’ve picked a winning company that you believe will continue growing at a steady clip, why let it go? The Action Bias will always push you to churn your portfolio frequently, more often than not to your detriment. Fight the urge.

Notional Losses – a difficult thing to stomach

As investors, we naturally tend to peg ourselves to the ‘highest watermark’ when it comes to the valuation of our investments, and hang on to that number. This tendency works against us, as we keep calculating notional losses in our minds. As an example, consider the recent price trend of MRF itself. In June this year, it made a high of Rs. 74,147 – valuing Ravi’s 20,000 shares at Rs. 148 crore. Today, barely a couple of months later the same 20,000 shares are worth Rs. 132 Crores – a steep valuation drop of Rs. 16 Crores, more than most people would earn in their entire lifetimes.

In fact, the 16-year journey from Rs. 500 to Rs. 62,000 has hardly been a straight-line graph for MRF. During the crash of 2008, The stock plummeted nearly 75%! More recently, the stock witnessed a dip of 25% in 2015-16.

The question here is – would you be able to sit tight and stomach such notional losses? Most likely, not. The loss aversion bias would take control of your brain and you’d jump in and out of the stock, move into other stocks altogether – or for that matter, disgustedly swear off equity markets altogether, only to re-enter near the next peak.

Notional Losses are difficult to stomach, and cause us to react in all kinds of irrational ways. Great investors know how to ride the tide when stock prices and fundamentals don’t agree with each other. They understand that the pendulum swings both ways.

Overdiversification

The ‘original billionaire’ Andrew Carnegie once said this about diversification– “Put all your eggs in one basket, and watch that basket closely”. Admittedly, the statement is slightly extreme, but it does capture one of the most important – and oft ignored – aspects of investing success: do not over diversify. Too many retail investors pile on a mammoth number of stocks, mutual funds, bonds and other securities – mostly on tips, news or hearsay. This results in an under performing portfolio full of worthless junk over the long term. Winners, if any, are obscured to the point of insignificance, their out-performances negated by the losses incurred in their poor performing counterparts.

Not many investors make a sincere effort in understanding the companies behind the stocks that they hold, preferring to ride the roller coaster of speculation instead. While you don’t need to concentrate your life’s worth into a single share, you might want to hold a relatively concentrated set of shares of companies that have great fundamentals, with business models that you understand. After all, shareholding represents ownership – and the last thing you should do is own something that you don’t really understand.

"This article was contributed by Guest author, Aniruddha Bose, Editorial Consultant with BW Businessworld and was posted on www.businessworld.in.”

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