Don’t go by market moods

Tulip was the flower of choice way back in 1637. Its graceful stem, topped by a single, vivid flower, led some to believe it was more beautiful than a rose. In that year, the Dutch were specially enamoured with tulips. It was the flower of the super-rich. If you were a skilled worker, you could get up to 10 years of your salary for a single flower.

But as one would expect, these sky-high prices did not last very long. Soon, the prices had fallen to realistic levels, and people who had invested in tulip farms had lost a lot of money. This event came to be known as the ‘tulip mania’, or ‘Tullipomania’, and is generally considered to be the world’s first recorded economic bubble.

The tulip mania is almost four centuries old now; but financial bubbles are not. Investors still get lured into investing into these bubbles, and the more gullible invest at the peak of the bubble. When the bubble is at its highest, it looks so attractive that no one can imagine it bursting. All financial bubbles point to one main takeaway – sticking it out over the long term, and not getting swayed by the current market mood as it will help you build wealth.

Returns in the short term are generally not good indicators of how an asset is going to perform in the long run. When the market is in a bull phase and is continuously rising, many people are attracted to it. They invest in stocks expecting to double their money in a few months, or a maybe a year. At the height of the bull phase, this may hold true temporarily.

However, what follows a bull market is a crash, and a prolonged bear phase. When the hopes of doubling their money overnight is dashed, people generally end up quitting. They sell their holdings that were bought when the markets were overvalued, for whatever value they can get out of it, never to invest in in an asset class like equities again.

What they miss out by doing this is the opportunity to buy when prices are down, thereby bringing down their overall investment cost. They fail to earn strong growth in the long term simply because they were too hung up on the short term trends of the market.

A bull phase doesn’t indicate that the market will keep rising forever. Similarly, a bear phase doesn’t indicate that the market will never rise again. Bull and bear phases are short term trends. The long-term trend is always positive.

Stock markets generally give positive risk-adjusted returns over a long period of time. If the Sensex fell 61 per cent in the 2008-09 crash, it bounced back with a 157 per cent gain after the tide turned. If it seemed to go nowhere for most of 2013, it surged 65 per cent in the bull market that followed. So don’t time your investments based on what the market is thinking at the moment. A well-diversified portfolio of good stocks held for a sufficiently long period of time is the best way to build wealth for the fulfilment of a long-term goal. And, because most of you may not have the time or the expertise to spot the long-term winners, mutual funds are here to help you build that portfolio.