‘Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves’ – Peter Lynch
Have you heard investors say that the markets will correct soon? Or that there is a crash just around the corner? Or that this is the time to take money out of the stock market and not put money in it because everything is so overvalued?
These are some common thoughts that many investors have while investing/trading in the stock market. I would be lying if I say I have never had these thoughts. But over the years these thoughts have caused me a lot more harm than good. Let’s see how?
Markets/Stocks can stay overvalued – Let us suppose that the investor anticipating a correction is correct about the opinion that the market is overvalued (debatable). ‘Stocks can trade above their intrinsic value or below their intrinsic value for extended periods of time’ – Warren Buffett. The problem is that even if the markets are overvalued, it doesn’t necessarily mean that they will correct. There have been times when arguably the markets were overvalued but did not correct for years.
Time in the market is much simpler than timing the market – Now let us suppose you were correct in predicting that there will be a correction and the markets did correct the following week. Now will you invest or wait for it to correct more. What if you wait and the following week the markets recover again. The problem is that predicting what the market is going to do in the following week with consistent accuracy is impossible. And the bigger problem again is that while attempting to do this investors often end up losing money, either by taking impulsive trades or by missing out on a fantastic rally. This is why staying invested through the thick and thin is the only time tested strategy that works each and every time.
Risk vs Reward – Let us assume that there is a stock that is currently trading at Rs 100. Let us suppose that you are planning to invest in it with a price target of Rs 200. You also believe that the stock might correct 10-20% in the next few days and that is when you will invest. This means that you are not investing in a perfectly good opportunity for an extra gain of Rs 15 (If lucky).
Now the bigger problem here is that the expectation of a 10-15% correction is mere speculation. Therefore, there is no reason why instead of correcting 10-15% it may go up 10-15%. This means that when you try to time the market or predict a correction, what you are basically betting on is your instinct in the short term and that to us is pure speculation. We find the risk of missing out on a great stock opportunity far greater than the reward of an extra 10-15%.
As we keep saying, ‘We have always found being 70-75% to 90-95% invested more comfortable than 0-100%’. This means we neither miss out on a market rally and have enough buffer in case of a correction.
Emotional discipline is much more important than IQ to generate good returns in the stock market. Keep it simple. Follow the rules. Stay Invested. Watch compounding do its magic on your Wealth.!!