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You Shall Not Pass: Determination and Boredom in ‘Range-bound’ markets

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“You Shall Not Pass.” This was famously used in J.R.R. Tolkien’s The Fellowship of the Ring, the first volume of The Lord of the Rings. In the novel as well as in the movie based on it, the wizard Gandalf declares staunchly, “You shall not pass!” while blocking the Balrog (a demonic creature). A bit of googling reveals that the phrase was originally used during World War I, during the Battle of Verdun, by a French General, Robert Nivelle. It has since been used as a slogan or a war-cry to express determination to defend a position against an enemy.

You-shall-not-passIt was this kind of determination that was required today in the Lords Cricket Test that India lost to England. Nobody quite strongly said “You Shall Not Pass” to the English bowlers, and it was a matter of time before it was wrapped up.

For the past few months, the market too seemed to be tied in a deadlock with the bulls and the bears saying ‘you shall not pass’ to each other, and not allowing either to get the upper hand. It has been a time when most business channel anchors use the term “range-bound” so often. It is so uninteresting to them to wake up every day in the morning, cover the hectic activity minute to minute, and finally it all ends up being ‘range-bound’ activity with ‘stock-specific’ action. There have been event after event created – from seemingly important ones like release of inflation numbers, quarterly results, IIP numbers, credit policy, Greek crisis, oil prices, European debt crisis, Chinese slowdown to tactical issues like expiry of the monthly series and daily volume turnovers. But the net result for the market has essentially been status quo. The end of every event makes everyone look forward to the next one – but the market again says – You shall not pass – I stay where I am – ‘range-bound’.

For an individual investor, perhaps neglecting all the action (or net inaction if you may say so) continues to be the best strategy. Lethargy bordering on sloth remains the best policy. The formula remains the same – fix your long term asset allocation, select and regularly keep adding to those assets, and rebalance once in a while when there are major moves. To everything else that tries to distract you from this path – the response should be – You shall not pass.

The End of Magic: Tribute to the Last of Harry Potter

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Avada Kedavra said Voldemort for the last time yesterday, and in the final battle, when the curse rebounded, it signified the last victory of Harry over his evil bete noire. The audience applauded heartily for the final time, and as my son and I left the cinema hall, he was left with an empty feeling that this was indeed the end.

harry-vs-voldemortMy son was just born when the first hints of Potter-mania hit the world, and to that extent, we have been late entrants into the Potter club – only perhaps for a year or so. But in that year, Harry, Ron and Hermoine along with Dumbledore, Snape and the entire professor-hood of Hogwarts, plus Voldemort and his Death-eaters had well and truly taken over our household. In a relatively short period of a year, reading all the seven books one by one, some of them twice, and then watching each of the first seven moves at least twice, my son had become a walking encyclopedia on Potter and his gang. And doing what only a 10 year old Potter fan can do, he had successfully converted his parents, both his sets of grand parents and perhaps most of his friends in to die hard Potter fans too.

It was then that I realised how much of a void the end of this last movie is likely to create in a generation of children (and their parents) that grew up on Harry Potter. Right from mesmerising children with the initiation in the early couple of movies (which most people watched agape) to almost frightening their parents in the last two Deathly Hallows, the rivalry of good and evil in a world of magic cast its spell on a generation of children. The last few months our home has been full of children making wands from broken twigs playing ‘Expelliarmus’ with each other, riding on imaginary broomsticks playing quidditch with their snitches taking roles of Harry, Ron and Draco, and calling their parents ‘Muggles’. As the early playfulness of the three friends quickly matured into an intense plot of rivalry, the games suitably changed with the early characters of schoolmates being replaced with Dumbledore, Snape and Voldemort and his deatheaters.

But beyond the now familiar spells, characters and the world of magic that Rowling and the movies based on her books took us into, there are some amazing subtle hints of wisdom that she threw at children – through the words of some amazing characters, specially Dumbledore and sometime Sirius Black and Severus Snape.  Like when Dumbledore tells Harry in the Chamber of Secrets: “It is our choices that show what we truly are, far more than our abilities.” Or tells him in the Prisoner of Azkaban: “Happiness can be found, even in the darkest of times, if one only remembers to turn on the light.” Or when Sirius Black advises Harry in the Goblet of Fire: “If you want to know what a man’s like, take a good look at how he treats his inferiors, not his equals.” And finally the one that I heard Dumbledore say yesterday in the Deathly Hallows when Harry asks him whether this is real or it is happening in his head: “Of course it is happening inside your head, Harry, but why on earth should that mean that it is not real?”

CA.0802.harry.potter.hallows.2.For mere ‘muggles’ who have not quite experienced this magic, it has always been a puzzle what the fuss is all about. But for those who have had this potion, it is always a case of the charms taking over. Finally it all ends – as far as the books and the movies are concerned. But it will continue to stay with this generation forever. Perhaps by some spell of magic, it may get a rebirth too. So till we meet again on platform number 9 and a 3/4, this is indeed the end of magic as we know it.

What do ‘Horn OK Please’ and ‘Mutual Funds are subject to Market Risks’ have in common?

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Travellers on Indian roads would be very familiar with this sign. Almost every truck, specially the big inter state ones that cross highways, has this funny term written behind them “Horn OK Please”. I have seen it often, and have never quite understood its significance. Having asked a few people, even they seem to be unaware of the meaning of this term and why it is there. Some say it is a warning for drivers behind the truck to blow the horn before overtaking it, which seems to be the most plausible explanation. Others say that O.K stands for On Kerosene as trucks earlier were run on them, so it was a warning for vehicles trying to overtake such trucks. In any case, it seems like it was supposed to be some kind of a warning for people following a truck.

Perhaps, it is now just a meaningless tradition that most truck owners and drivers blindly follow – painting their trucks with a “Horn OK Please” sign without really meaning much. The funny thing is that no one cares for that sign too, except for some amusement factor. Sometimes not even that. No vehicle following trucks (other trucks included) cares for that sign or follows it – they overtake anyway as they wish.

So what’s the point? I got reminded of that funny sign behind trucks a couple of times today while watching a business channel. The first occasion was when watching a mutual fund ad, at the end of which there was this scrambled, hurried announcement. “Mutual Funds are subject to market risk. Please read the offer document carefully before investing.” And the second one was after a show discussing stocks, in which an expert just before wrapping up, announced a quick disclosure shown also on screen. “I, my company or our clients may have positions and interest in all the stocks discussed. Viewers are advised to take their investment decisions at their own discretion based on advice from their financial advisor.” Or something to that effect.

Both these statements and the manner in which they were made sounded to me like “Horn OK Please.” Almost all experts on the show (and all other shows) as well as all mutual fund ads ended with these statements. The people making these statements did not quite know why they were making it – perhaps they were following some tradition or regulation in this case. They were kind of making them blindly without really meaning much. Like the truck owners paint their trucks. And the people for whom these statements were made, presumably investors and traders, were not likely to take those statements seriously. They were, anyway, not going to read the offer documents, or were unlikely to neglect the advice or recommendation given just because someone had a vested interest in them. Perhaps similar to how other drivers view Horn OK Please. You read it, but you overtake anyway.

Neither the maker of the statement means them, nor do the readers take them seriously. Perhaps, both get some amusement out of it. Striking similarity with “Horn OK Please”?

No News is Good News: Is Your Expert Service Provider also Honest?

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The wife has been feeling a bit unwell with frequent abdominal aches for the past few weeks. (I am going to refer to my wife as “the wife” like the humorist Busybee used to in his articles in Mumbai’s “The Afternoon” so many years back – I used to find it so funny). So well – getting back, the wife has been a bit unwell. I have a mild version of hospital phobia, despite the wife being a doctor. In a sense, that works well because the wife takes health decisions for everyone at home – on which illness is to be neglected, when you should be happy with just some medicines and when an illness is to be taken seriously enough to visit the hospital. So this time, the wife being the patient, took a call that enough of medicines – it was time that she needed an “endoscopy”. So we finally got an appointment, went to the hospital and got it done. Well – after that, the surgeon called me in, and very dutifully showed me all the photographs and videos that the endoscope had recorded. I blankly nodded with a studious look pretending that I understood everything he said, as if I see the insides of stomachs day in and day out. And finally, at the end of it, he said something to this effect – there is nothing, it is all fine and normal. Just a bit of gastritis, let her manage her lifestyle and health, do not give her stress and things should go away. You do not worry.

Once I got out, I asked the wife – so you have no illness? No indeed. So there was no news as such. We got through a procedure and there was no news. Which actually was good news.

The wife was pretty cool about it. This happens all the time she said. Patients who feel they have a serious illness due to pain in the stomach turn out to be simple gastritis patients 80% of the time. As the conversation progressed, she continued – “In fact, doctors admit them just because patients refuse to go back often. And sometimes, not just that, the patient who is not ill ends up picking up an infection from the hospital! So, if you are seriously ill, your odds of getting better improve when you get admitted, but if you are not seriously ill, the odds of getting worse are more! Now you understand why I neglect most of your petty illnesses at home.” Towards the end, I thought that was not the doctor speaking, it was the wife.

Be that as it may, it sounded amazing to me – but then I guess doctors are people too, doctors are wives too. The wife continued – “But this doctor was good and honest too. He did not tell you that we will need to observe and prescribe something more. Maybe because I am a doctor here.”

So that was it – we found a doctor who was honest enough to tell us – you do not need me. And a patient who was obedient enough to listen to him.

This is not as common as it looks. Perhaps in medicine, you have more honest doctors and more obedient patients – because it is about your life and health. So the chances of coming across such doctors still is high – despite all the corporatisation of healthcare and the works. But it struck me that in other areas where people are supposed to be ‘doctors’ or experts in their fields, they do not always act with that kind of integrity. How many experts at auto service stations tell you when you take your car for a check up that “Your car does not need me”? How many accountants will tell you – well, everything is fine with your accounts, why don’t you file your returns yourself? How many financial advisers to whom you take your portfolio are honest enough to tell you “Your financial health is fine and this is why you do not need me”? And finally, how many of us would be happy with these kind of advisers, and like good patients – obedient enough to take their advise? Has it ever been the case that when you engaged some of these ‘doctors’ you were perfectly fine and then caught an infection?

Something to ponder upon. Well – the fact is that instances of finding experts who say – “you do not need me” are few and far between. It is possible that you do need some medicines some time, but if according to your expert, you need them all the time, perhaps it is time to change your doctor for these areas. Move to someone who gives you no news. Sometimes, no news can be good news.

The Price of Everything and the Value of Nothing: Recognizing Intangible Value in a Business

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I am a Maruti vehicle owner, and a highly satisfied one at that. The overall cost efficiency of their vehicles and the tremendous value they provide is legendary. It is aptly shown in that funny ad in which a rich man is being sold a luxury ship by a sophisticated salesman, and at the end of it he coolly asks – “Kitna deti hai?” Maruti can take the credit for (or is guilty of – based on how you look at it!) making Indian car owners used to a certain minimum standard of fuel efficiency. And that sort of dependability (and many other benefits that car owners attribute value to and which Maruti has mastered) tends to tilt the car buyer’s decision in favor of Maruti more often than its competitors – at least on Indian roads. In a very conscious or unconscious way, customers assign a value to their purchase, and compare it to the price at which it is being offered, and if the gap is there – they seem to go for the purchase.

In my profession (technology and management consulting) often I am required to sell our offerings to other companies using what is commonly known as “Preparing a Business Case”. In most cases, the approach taken to create a business case is what I broadly like to refer to as the ‘route of efficiency’ rather than the ‘path of effectiveness’. And the reason for it is simple: it is easier to quantify efficiency, and very tough to quantify effectiveness. So for whatever it is worth, one goes about getting some numbers around how much time will be saved due to automation, or how many man hours will be saved due to process time reduction, or how much material will be saved due to lesser turnaround time. Despite that exercise (which has its own value), I have often experienced that companies that finally end up buying do not do so, only because of the price justification in the business case, but due to some additional value perception that they see. That value perception often means different things to different customers in different circumstances, but unless that happens, the business case alone is not enough and the sale does not happen. And in a competitive environment, that value perception is the ‘thing’ that tilts the customer to choose a seller.

price-value-compete_on_valueIt is easy to offer a price, but very difficult to quantify that value perception. Companies that can consistently offer this value relevant to their markets, and whose customers choose them for this intangible value perception are themselves candidates for outstanding long term value.

As customers of various products, we are exposed to offers on multiple things at multiple prices everyday. As prospective customers, most of us are smart enough to evaluate the value in what is offered, then check the price, and if there is a gap, we grab it with both hands. A lot of ‘up to 30% off’ offers are simply stripped down products at slightly lesser prices, and most of us, after checking on them – reject those kind of offers. Some of them are genuine ‘sale’ offers or turn out to be great bargains, and we are smart enough to recognize those too.

But as investors, a lot of us are not that smart when choosing company stocks to buy. We forget that price is one factor, but whether the company is of value is the important one. A new promoter tries to sell part of his company which has just started making profits (an IPO is just that!), but we still buy it even when an established company is available for purchase every day – perhaps because “it is cheaper”. We see on business channels, the reporter routinely making statements like “retail investors seem to have come back  to the market as there is more action seen in mid and small cap stocks” – thereby meaning that they buy the stocks that have lower price. A friend of mine ‘invests’ in penny stocks because “it is 12 rupees, so even if it moves by 10 rupees my money will almost double”. Another acquaintance never understands why buying a 10-year-old mutual fund unit costing Rs.200 per unit is better than buying in a new fund offer for Rs.10 – “I am getting 500 units for Rs.5000 in the new fund”. It is almost like going to a grocery store and asking for a soap for under Rs.5 – well you may get a soap, but it is not going to wash anything much!

That is not to say that there is no value in low-priced stocks. Like bargains for any other product, there could be, but price cannot be the sole reason of purchase. It is best if the starting point of any purchase is at least a broad evaluation of what constitutes value for you. When the value seen is reasonably close or under the price at which it is offered – be it for someone buying cars, software or company stock – it results in a good purchase. But a great purchase is perhaps made, when you not only get some of these quantifiable measures of value, but also know that there is some more value offered that is pretty certain and perceived, maybe not easily quantifiable and replaceable. The kind of value you have when you know that customers in India prefer Maruti cars for some reason. Or that it is almost impossible for someone even with a lot of money to replace Cadbury or Disney from a child’s mind. Or Americans for some reason love Coke. That is when you know that when such value is available cheap, it is not a “up to 20% off, conditions apply” kind of sale, but a genuine bargain on a quality product.

Buffett said that price is what you pay, value is what you get. The ability to get this difference is critical. Else like Oscar Wilde said we will “know the price of everything and the value of nothing”.

How to Use Loans and Prepayments to Your Advantage

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The banking industry is a very funny one – whose basis for lending is that of insecurity. A smart individual investor can use it to his advantage to create wealth. In a consumption oriented and growing economy, most households have some exposure to debt of some kind – the most common being housing loans and car loans. A lot of popular advice or propaganda is centered around how much loans to take, how to save for down payments, how to negotiate on interest rates, how not to get under the debt burden, etc. Also further on how a housing loan makes sense, a car loan may be ok, but personal loans and credit card loans are avoidable. These are all valid topics and important micro advice, things to be carefully considered before one goes out and borrows. But for an individual investor who gets caught up in them too much, they can be akin to focusing on the small stuff and missing the bigger picture; focusing on data and information, missing out on knowledge and wisdom. A lot of that big picture view about loans and their prepayment that might be very important, and something that is structural.

home_loan_prepayment20110907013037Fundamentally, as I said, the banking industry is based on the premise of insecurity. Let me elaborate. It wants to give money out because it is in the business of lending and making money out of it. So it wants to make sure that its capital is safe when lent to someone. Hence it has processes to evaluate credit worthiness of individuals, and depending on the stage of the economic cycle, that process either gets lax or becomes stringent. But further to that, once the creditworthiness is established, the way a bank or any lender makes money is through the interest the borrower pays. So it also wants to make sure that it is going to get the interest. Which means it does not want too much of prepayment, else it loses out on interest and its profits may come down. Hence it comes up with two mechanisms – one, it collects most of the interest in the initial parts of the loan tenure when it assumes that most borrowers are unlikely to prepay, and two, it charges penalties on prepayment anytime during the loan tenure. That’s the reason it is playing to balance two types of insecurities. The first insecurity is that of principal repayment or fundamentally loss of capital, and the second insecurity is loss in collection of interest. Its security against loss of capital is processes to evaluate credit-worthiness and mortgage or hypothecation of the asset i.e. housing or vehicles. And its security against loss of interest is prepayment penalties or general discouragement of too much prepayment. An individual investor who understands this can take advantage of this insecurity of the lender to build wealth.

So what is the way? The way is simple. The trick is to put a slightly lesser amount in down payment than you can afford to, take a higher loan initially, negotiate no prepayment penalties, and save more cash in the early loan tenure to prepay part of the principal. How does this help? The structure of most loans is such that if you do not prepay in the first few months or years, the interest gets collected by the lender via the installments. The key for an individual is to ensure that larger part of that installment is going towards principal rather than interest. That never happens when it is most needed i.e. in the initial tenure of the loan. The traditional advice given is if you can earn more than the interest rate on your loan through other means, do not prepay, specially on a housing loan – where reasons such as it is an appreciating asset and you get income tax cuts are provided as further reasons on why not to prepay. But that is exactly what works to the advantage of the lender rather than the borrower. If one looks at the structure of a loan, it is not about interest rate, but about absolute interest that you pay in the first few years. You may be paying a uniform interest rate, but collection of the interest amount is not uniform – it is skewed in favor of the lender. So even if you garner more returns than the rate of interest on your money through other means of investment, the bank has already collected the interest early. The borrower’s returns on money not prepaid will compound only after a few years once capital and returns accumulate, but the bank’s interest gets paid early in the tenure. So if the borrower prepays early, he stops compounding of that interest for the lender early on by reducing the capital outstanding. This gets even better for depreciating assets like cars where interest rates are higher, and the asset is depreciating – so you are essentially paying interest for asset usage and left with some small residual value.

There are no two ways about it. For the borrower, the effects of early prepayment even in small amounts are unequivocally positive, and can be almost magical in terms of interest savings. A borrower can check amortization calculators to check on the impact – it definitely is more than what most individuals expect. And if one has managed to buy an appreciating asset at the right price, has a reasonable loan to value ratio, and low EMI-to-income ratio, it is a sure recipe for creation of wealth over the long run at the expense of the lender.

The trick is in managing that well. The financial industry will try its best to trap borrowers with a high loan to value, high EMI-to-income ratio, and high prepayment penalties – which means a borrower will have no option but to keep paying EMIs regularly for a long period – by which time the lender has collected interest and made money on your loan. And after which point, there is no logical incentive to prepay as the loan has now become cheaper. The risk of the loan for the lender is gone. The trick is to be in a position where you can prepay early in the tenure, and let compounding of interest (or lack of it in this case) work for you rather than against you.

Of Barbers and Brokers: Why it is important to know what you are looking for

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Every few weeks, Saturday mornings are reserved for the barber. Today was one of those, so my son and I had our visit to the salon. After our customary drive and parking, and a few minutes of waiting for our turn, we finally were called in and sat into our ‘throne’ to get started with his ‘services’. Mind you, salons in major cities in India have got quite savvy. So unlike a few years back when you just went to a barber shop to get a haircut, now you go to a wellness salon which provides ‘overall hair and beauty services’. They have a quite a range of services on offer to grab more ‘share of wallet’ from you.

But despite that some things have not changed. So the first question I get when I am seated is still – ‘do you want it cut short, medium or long?’ I have never been able to figure out what to answer this question with. Obviously, long is out of question, else I would not be here. But between short and medium, I have never figured what I really want. When I say short, I kind of need to clarify that I do not want an army crew cut. When I say medium, I generally follow it up with some comment that suggests – but do not cut just a bit! After that, I hope he has got what I want and then silently sit waiting for him to do his job.

This is similar to the ‘agony aunt’ stock question-answer programs you have on TV. So the caller asks – I bought so and so stock at Rs.100 two weeks back – what should I do now, buy, hold or sell? And the advising broker asks him – can you hold for short-term or long-term? Similar to ‘do you want your hair short or medium?’, this question has no clear answer. So the caller answers, long-term, and just to clarify – adds 2-3 months!! Providing clarity for his definition of long-term.

The other similarity I find between barbers and brokers (or as they are called hair and beauty service, and financial service providers respectively) – is their nice guy approach when the first service is over. So I am nearing the end of my hair cut, and typically I am asked – “Sir, will you like a hair color?” Now at this point, if I am not clear on whether I want it or not, it is quickly followed by something like – “It will look good on you Sir” or something to that effect telling me why I need it. Depending on the tone of my answer, the same service is pursued, or a new item in the menu card is proposed – the hope being that the 5 minutes between now and the end of my hair cut yield an add-on service that I purchase.

This is again similar to my experience with financial services providers of late. If I visit a bank, a ‘relationship manager’ arises from somewhere telling me that he will be the point of contact for me. So after some mundane task like submitting an application for a bank stamp on an ECS mandate is done, and I am waiting for the processing, the relationship manager quickly asks me if I am looking for stock and mutual fund advisory services, or else for insurance, or for credit cards – for something. A little bit of confusion shown on my face, and I am drowned in information on why I need it. Only when there is no option but to give me my ECS mandate, I am free to go.

So here we are, in the savvy new world of services with so many things on offer. A slight bit of confusion on your face is a sure sign for marketing spiel to follow. In such a scenario, whether it is barbers or it is brokers, it is important that the buyer is clear on what he wants, and not just that, is quite staunch about it. An extra hair color at a salon may not cause much harm, but a wrongly bought financial service or product is likely to do so. So as has been said by famous investors earlier, never ask a barber if you need a haircut (or for that matter any other hair and beauty service). It is in your interest to be clear about what you want. If at all you have a need to ask, ask someone whose advice you trust and will provide advice that is in your interest. Because whether it is a barber or a broker, like Lewis Carroll said – “If you don’t know where you are going, any road will get you there.”

Of Skill, Temperament and The Wall: Investing Lessons from Rahul Dravid’s batting

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A couple of days back I was privileged to watch one of the best recent displays of classical Test Match batting by Rahul Dravid. That day (as so many times in the past too), Dravid secured a painstaking century on a minefield of a pitch to get India into a position of victory. He has done so earlier on similar pitches against much lethal bowling and in worse team situations. What is amazing is he was never directly focused on getting the runs. Runs seemed to be incidental outputs. His singular focus was to handle each ball as it comes, survive and score when possible – which in turn led to the century and eventually set up India’s victory. Dravid has been following that approach for the past 15 years, ball after ball, match after match, year after year – and it is no surprise that he is India’s second highest run getter in Tests.

dravid1Well – this note is not about his achievements or why he remains my favorite Test batsman. This is about the approach he brings to batting. There is so much to learn for individual investors from the way Dravid bats. If only one thinks of oneself as Dravid, and everything around him as the markets – the pitch, the bowls coming down, the excitement,  the team situation, one will realize the value of his approach and its application in the area of investing.

Dravid’s approach to batting is akin to Graham’s or perhaps even Buffett’s approach to investing . The first rule is never lose your wicket i.e. never lose money. The second rule is always follow the first rule. His expertise and experience in handling pitches like Sabina Park is tremendous, but he is still a student. He still does not know what exactly it has in store – i.e. which ball will seam and which will bounce, and does not try to pre-judge. Very much akin to the vagaries of the market which are futile to predict. His mind is almost trained with a plan for every over that sounds like – leave, leave, defend, leave, score, defend. His patience wears off the bowlers, so that they start bowling to where he wants them to.  dravid2

They try out-swingers which he leaves even if slightly off line, bouncers which he ducks without any ado, inswingers and short pitched balls which he gets behind and defends solidly. And finally he gets a wayward delivery on his legs which he flicks, or one that is wide outside the off stump which he drives. The entire process and journey by which he collects his runs and builds his innings is amazing, and more or less guaranteed to provide success if anyone could follow it well.  Wickets keep falling and other batsmen score faster with boundaries from the other end, but when Dravid is at the crease, he is still thinking – leave, defend as his natural choices by default, and only if the ball is in his zone, he scores. And those opportunities surely come more often than not. When everyone around him is struggling – including the bowlers unable to comprehend what the ball will do next on this pitch, fielders bored with nothing seemingly happening, and non-strikers flashing their bats in a bid to do something – Dravid is patiently batting – in his zone.

dravid3Isn’t the experience that normal individual investors have in the market similar to what batsmen face at pitches like Sabina Park most of the time? Sometimes you do have belters in big bull runs where you just get bat to ball, and it flies to the boundary. Investors that invest the way Dravid bats may temporarily look like fools on such belters. But most of the time, the markets are pitches like Sabina Park. You never know which way it will go. Defend or Leave is perhaps the best option for most individual investors on most deliveries thrown at them. Patience is then the biggest virtue, specially when you have a long innings to play. And when the market wears out and throws you a sitter, you grab it and accumulate your runs. If you do this ball after ball, match after match, year after year, through multiple economic cycles, good form or bad, a couple of things are sure. It is very unlikely that you will get out on a bad ball i.e. you are unlikely to suffer huge losses due to making bad investments. Most investors never recover or get back to markets after that. And finally, it is very likely that you will end up with a tally like Dravid’s by the time you are done.

The Six Hats of an Individual Investor

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Dr Edward De Bono came up with a famous theory of the six thinking hats, as a tool for group discussion and also individual thinking – as a means to think from all angles, more effectively, and to come up with successful decisions. The contention of the six thinking hats is that the human brain is capable of thinking in multiple ways, and hence, if – for critical decisions – an attempt is made to deliberately think in each of the six different ways, a new and better decision may be possible.

Six-Thinking-HatsFor an individual investor, I think something similar to make successful investing decisions over time may be required. Here is an attempt to articulate the six hats that may be required for effective investment.

Analytical Hat: While the ability to gather facts and analyze information is quite important, in my view, it may be a bit over-rated. It is certainly not the most important ability required in an investor. Though it is necessary, by no means is it sufficient. The analytical hat is perhaps the starting point, but just about it.

Optimistic Hat: An investor needs to be an optimist at heart. Investing is about putting money in the belief of better returns of the future. Hence, unless an investor has a positive view of the future, it is unlikely that he will hold his investments, specially during downturns.

Skeptical Hat: A skeptical outlook which looks at all businesses, advice, opinions and information with a pinch of salt – like ‘guilty till proven innocent’ is extremely important. It may seem contrary to the optimistic hat – but it is not. The most important advantage of a dominant skeptical hat is to avoid big blunders – which is as important as making the right decisions.

Patient Hat: The capacity and willingness to endure waiting, delays or provocation without getting upset or losing track – is perhaps the most important hat that an individual investor will need. It is also the one required the most often. At so many points in an investor’s life, the other hats will have nothing to work on, and the only hat in operation is the patient hat – and the ability to endure that is invaluable.

Wisdom Hat: There is a lot of knowledge but no wisdom. That is an apt characterization of the state of capital markets in today’s connected world. An innate wisdom hat allows the investor to discern and make a judgement on what is the right thing to do, or whether to do anything at all is extremely valuable. Perhaps one of the most critical hats for an individual investor.

Rebel Hat: The ability to refuse to obey, or go against what may seem like popular is the Rebel hat, that will need to come into play in times of high swings in the market. And the rebel hat will ensure that the investor buys when everyone is telling him to sell, or sells when everyone thinks he is a fool in doing so. Importantly, a rebel hat combined with the others is necessary for the big returns.

So here are the six hats required for an individual investor. At various times, one hat may seem to be more prevalent than the other. But like Dr De Bono’s contention – a deliberate attempt by an investor to wear all hats before making investing decisions, will perhaps ensure that the right decisions are made most of the time.

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