Made mistakes in the last bull market? Here are eight lessons to become great next time

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”

WILLIAM ARTHUR WOOD

From the past couple of days, I was documenting the most important lessons that I learnt from the stock market post the melt down. I was also analyzing the poor investment decisions that I took, the findings turned out to be quite interesting and insightful. Hence, I decided to convert it into a blog post.

Here are the eight most important lessons that I learnt from the stock market.

1) Passive Investing and Portfolio Diversification

Source: https://dilbert.com/strip/2002-08-04

For newbie retail investors, putting one’s entire savings directly into equities before experiencing a complete market cycle could be lethal. Retail investors generally don’t read three-five years annual report before investing in a stock, they don’t even actively manage their portfolio. In my humble opinion, such investors should direct a chunk of their investments (say 50-75%) towards a mutual fund. Rest of the investment could be invested directly into equities (stay invested for a complete cycle and learn) through a diversified portfolio. Although successful investors have made big gains from a concentrated portfolio but that requires massive expertise in the area of competence which most of us lack. I always believed that knowing the horizon of your competence is important but it is far too important to know that ignorance expands disproportionately as one tries to expand her area of competence.

Therefore, in my humble opinion, passive investing and portfolio diversification (not more than 8-10% in one stock) is a sensible strategy for long term wealth creation for newbie retail investors.

2) Beta is Under-Rated and Alpha is Overrated

Source: https://dilbert.com/strip/2015-02-25

During the year 2017, I met dozens of equity investors- all claiming to be ‘astute investors’. Most of them seemed confident that they had figured out how to pick stocks- without reading any book, without seeing a complete market cycle and without following any strategy. I vividly remember that during the last quarter of 2017, I and my best friend were concerned about our high exposure into midcaps. Although our portfolios were performing well, yet we were concerned whether it was our stock picking skills or was it just a rising tide lifting all boats case. We decided to meet-up for snacks at a Kathleen outlet in Kolkata. There we got to know that the cake shop owner and the cake supplier both had decent amount of exposure in equities. When we tried to dig deeper, some interesting ‘scrips’ came out – Reliance Communications, Suzlon Energy, Vakranjee, Everest Kanto Cylinders, Dmart, GMR Infrastructure etc. They had done no research whatsoever before taking the positions, rather they had relied on tips – Watsapp groups, Youtube videos, Telegram groups, text messages, brokers.

Interestingly, their portfolio gains had made them overconfident about their investing skills. After a few days, we went to the burning ghats of Kolkata to eat Litti Chokha (a north Indian dish). The Litti seller was giving us stock tips!

Back in Bangalore, I had gone out for a couple of drinks at a pub on the streets of Koramangala. I met a newly passed C.A. who told me that he had recently started investing into equities. He asked me for a few stock tips, I politely declined but I casually asked him about his portfolio holdings. His first pick was SastaSundar Ventures!!! He had done no research before taking the position.

Most people fail to understand that, ‘a rising tide lifts all boats’ and a raging bull market creates an illusion of knowledge. People mistake Mr. Market’s skill for their own skill and such mistakes are severely penalized in a bear market.

3) Fundamental Research is Painstakingly Tough

Source: https://dilbert.com/strip/1996-09-14

Recently, I met a working professional who was fairly qualified. He told me that he does proper research before entering into a stock. When I asked him to share his research strategy, he told me that he ‘Googles’ the stock and reads 10-20 articles diligently for over 1-2 weeks, monitors the price movement and checks investing forums. Once he is satisfied with the story only then he proceeds with the investment.

One should know that reading news articles and monitoring stock price movement is not fundamental research. Fundamental research requires patient evaluation of the business performance as well as capital allocation across cycles and then figuring out the true earnings power and sustainable margins. In majority of the cases, even reading five years annual report is not enough! Lay investor’s needs to spend a lot of time acquiring the skill and expertise to discern true business potential and competitive advantage and how they should be valued.

4) Corporate Misgovernance is Rampant Across Indian Companies

Source: https://dilbert.com/strip/2002-07-19

Although India has stringent corporate governance regulations on paper but in a majority of cases, the interests of the minority shareholders depend on the benevolence of the promoters. Siphoning of funds, conflict of interest, inappropriate disclosers, symbolic corporate governance is rampant across Indian companies as in many cases auditors and independent directors’ toe to the promoter’s line. There are innumerable cases- ICICI Bank, Yes Bank, Tata Motors, Bandhan bank, Vakranjee, PC Jewellers and many more. All these companies had respectful auditors and independent directors, yet they were allegedly involved in corporate misgovernance.
Since, it is not possible to completely know what’s going inside companies and accurately measure their standard of governance; portfolio diversification is the best risk management technique against potential corporate governance issues and accounting jugglery.

5) Don’t Fall Prey to the Narrative Trap

Source: https://dilbert.com/strip/2012-07-03

Retail investors should know that every bull market is created on the back of stories. Narratives are created, floated and served to retail investors like candies, what follows is testosterone surge, irrational exuberance and herding. Sometimes even large fund houses form part of the herd and it becomes extremely difficult for a retail investor to stay away from the noise.

Therefore, one should focus on fundamentals, competitive advantages, moats, valuations and not stories!

Read my blog post- Omax Autos, Gobar Gas And The Antarctic Bacteria for detailed understanding of bull market narratives.

6) Avoid Discounting Anything Bad That Can Happen to a Company

Source: https://dilbert.com/strip/2005-01-12

During the last quarter of 2017, my investment in Godawari Power and Ispat Ltd had grown 3 times in a span of few months. I booked my profits and as a result had some surplus funds to deploy (this kind of haste in deploying your surplus funds or recent gains can be lethal during a bull run, as we can fall victim to decision fatigue and fear of missing out). Fast forward two months, a friend of mine (qualified, disciplined, and a full time investor) tipped me Prakash Industries, a metal stock which according to him was available at attractive valuations. He shared his detailed calculations on the stock’s valuations. I took some time and did my research. I found a number of red flags with the company.

a) Prakash’s MD had been jailed in the past in a cheque bounce case
b) The promoters were allegedly involved in the coal scam
c) SEBI had classified them as a shell company (which was later revoked)
d) They had openly flouted SEBI norms in the past by falsifying their AGM notice (Read here)

Upon expressing my concerns, I was told that the steel industry was on the cusp of revival and Mr. Market had already discounted these corporate governance issues! I continued tracking the stock closely.

Did I finally invest in Prakash Industries?

We will discuss more on this in the next point.

7) Don’t Rely on Borrowed Conviction

Source: https://dilbert.com/strip/2012-06-28

I wasn’t very sure about the integrity of the promoters of Prakash Industries, but then I came to know that Rakesh Jhunjhunwala (RJ) and Mukul Agarwal were holding stakes and voila the next day I came to know that Dolly Khanna was gradually accumulating the stock too! (Read here).

By this time, I had already been taken over by fear of missing out (FOMO) and invested in the stock, only to book losses later. Although my instincts had warned me against this investment, I fell victim to three biases simultaneously:
a) Decision fatigue (gains from Godawari Power and couple of investment decisions taken in the quarter)
b) Fear of missing out (Prakash’s story seemed irresistible)
c) Social proof (followed RJ, Mukul Aagrwal and Dolly Khanna despite corporate governance issues in Prakash)

What happened to my investment in Prakash Industries?

Within months of my investment, an RTI activist claimed that the promoters were allegedly involved in benami transactions. The stock tanked heavily and I had to book losses. Few months later, the promoters were again booked by the Enforcement Directorate in connection with the coal scam. From here on, the stock had a free fall.
Lesson learnt; do not blindly follow successful investors. More importantly, never invest in a company having a long history of corporate misgovernance, phew!

8) Human Beings Often Fall Victim to Behavioral Biases

Source: https://dilbert.com/strip/2014-12-21

As I have already explained in my previous blog posts on behavioral finance (links provided below), untrained human minds are highly prone to cognitive biases. The most important edge in the market is analytical and behavioral and not informational, that’s why it is common to hear stories of millionaires who keep forgetting their system login credentials!

Understand popular cognitive biases:

a) The Lollapalooza Effect (biases explained- scarcity error, social proof, authority bias, envy, availability bias, incentive bias, bandwagon effect)

b) Why you should visit cemeteries (survivorship bias)

c) Did Karna fall prey to reciprocity bias (reciprocity bias)

Bonus Lesson (For those of who read so far and found this blog post interesting)

9) Don’t Lose Hope If You Lost Big

If you have lost big, don’t lose hope, as you may be wrong 10 times, but you shouldn’t be worried as long as you are learning and not repeating the same mistakes.

Source: Atomic Habits by James Clear


At one point of time, my portfolio was down over 40% but gains from just one multibagger compensated for more than the losses from my poor picks. Since then I have learnt two more important lessons:

For newbie investors, a strict stop loss rule is extremely important. Such investors often fall victim to borrowed convictions and take wrong decisions. In the initial phase of my investing journey, I met a gentleman who had been investing for quite a long time. He did not believe in a stop loss rule because for him ‘stop loss meant erosion of capital’! Since I too was a newbie then, he had left an impression on me and I too followed this kind of strategy for quite a while and sat on my poor decisions. But then gradually I realized, stop loss doesn’t erodes your capital, it rather protects your capital. I think of it as a premium that I pay to protect myself after taking poor decisions. Well, many investors believe that if you want to book losses after a stock tanks 8–10%, then you shouldn’t have invested in the stock at the first place (basically saying that, long term investors should only go for high conviction picks). This holds good for seasoned investors who are disciplined and follow their own strategy. But for a typical retail investor, the probability of falling victim to borrowed conviction and bull market narratives is very high, so apply strict stop loss until and unless you are absolutely sure about your decision. Remember, a 10% loss on a 10% allocation is just 1% loss of capital, while the wealth of learning is experienced!

The second lesson that I learned is this- it is important for you to burn your hands. If you lose big, don’t lose hope, good decisions have given me decent gains but poor decisions have taught me vital lessons such as dealing with your own emotions and importance of discipline in the game of investing. All of these lessons give us tremendous experiences which are extremely important for wealth creation in the long run.

Read more blog posts:

Omax Autos, Gobar Gas And The Antarctic Bacteria

The Lollapalooza Effect- Part I

The Lollapalooza Effect- Part II

Did Karna Fall Prey To The Reciprocity Bias?

Watch: Presentation on 
Deutsche Bank’s India Strategy Report

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