10 great investing rules from history

Remember that old adage to the effect that those who don't learn lessons from history are bound suffer avoidable hardship?
Learning the important lessons that history of investment offers, will rev up your investing profits. . .
1. Put all your eggs in one basket and watch that basket!
This saying comes from Mark Twain, but has been applied to stock market investment more or less verbatim by both John Maynard Keynes and Warren Buffett. Modern portfolio theory suggests that one can reduce risk by diversification.
However, if you were an active investor you would do better to concentrate your shareholdings in a limited number of companies which you feel you understand. This can actually reduce risk.
2. When the ducks quack, feed them
This is an old Wall Street adage relating to initial public offerings. Investment bankers are out to make money and will sell the public anything within the bounds of the law.
Research suggests that, in general, IPOs rocket upwards on the first day's trading but tend to under perform comparable companies over a three-year period. Since small investors don't receive fair allocations of the best IPOs but are landed with the duds, they should avoid the new issue market entirely.
3. Markets make opinions, not the other way round
When markets rise, commentators find a way of rationalising the gains. Take the tech bull market. We were told that the 'valuation clocks' were broken and that companies deserved to trade on a higher price-earnings ratio.
We were also told that US productivity had risen and that the US would experience a higher growth rate in the past. We were also told that Greenspan et al would prevent another cyclical downturn. All these comments were spurious rationalisations of an 'irrationally exuberant' market.
4. Buy low, sell high
This advice seems obvious, but investors always ignore it. The demand curve for investment assets is like that for a luxury good -- the higher the price, the greater the demand.
Hence we see turnover rising during a bull market and falling during a bear market. Investors should always be prepared to act contrary to the market.
5. When the rest of the world is mad, we must imitate them in some measure
This observation came from the mouth of an eighteenth-century banker, John Martin, during the South Sea Bubble of 1720. It is another expression of the 'greater fool' theory, namely that you can buy over-priced shares and sell them on at a profit to some sucker.
This speculative attitude has been much in evidence in recent years in the form of momentum investing. Of course, you can make money if you find a greater fool, but you also will lose your money if you don't.
6. During a bull market nobody needs a broker. During a bear market nobody wants one
This is another Wall Street saying, cited more recently by Alan Abelson in Barron's. We are now more aware than ever that most brokerage research is generally of a low quality and that broker recommendations cannot be followed profitably.
Investors should avoid reading research by brokers whose parent company provides financial services for the company concerned.
7. Every man his own broker
This is, in fact, the title of the first investment book, written by Thomas Mortimer in the 1750s. It was republished several times. If you can't trust brokers, you must replace them. The problem is that the private investor is not well-equipped to do so. So, first learn, then invest.
8. Markets can remain irrational longer than you can remain solvent
This saying comes from John Maynard Keynes, the great English economist. He was also an acute observer of markets and a speculator. The point of Keynes's comment is that your observation may be fundamentally correct but it can take the market a long time to catch up.
For example, the dotcom bubble ran for almost five years from the flotation of Netscape in the summer of 1995 to the Nasdaq collapse in March 2000. Many people lost a lot of money shorting the likes of eToys and Amazon.com before the market woke up to its absurd overvaluation of the sector.
9. A mine is a hole in the ground with a liar standing over it
This saying also comes from Mark Twain. It should remind investors to be wary of all projectors, whether they are promoting gold mines, biotech or some other new-fangled technology.
In general, the promise of outsize profits are followed by the reality of painful losses. You will make more money in the long run by restraining your greed.
10. Be diffident when others exalt, and with a secret joy buy when others think it in their interests to sell
This advice comes from the English writer, Sir Richard Steele, in an article for The Spectator in the early 1700s. To my knowledge it is the first expression of a contrarian investment philosophy.
The art of investment lies in judiciously going against the crowd. It is both intellectually more fulfilling to refute the market consensus and in the long run should be more profitable. Academic research suggests that unloved 'value shares' tend to outperform so-called 'growth stocks' over the long run.
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Financial crisis: Why bailouts are not the answer

Disasters and wars provide excellent opportunities for businesses to make money. Governments are in a mood to open the tap, there are fewer checks on decisions taken in a rush, and special interests can make merry.
The airlines who were hit by the 9/11 attacks seven years ago wrested big concessions from the government, though smaller businesses that were equally badly hit got nothing. A similar attempt in the United States has just failed, with the big American car companies failing in their bid to get a $50 billion bailout package -- which is just as well, because the history of such bailouts is not encouraging.

It is far better for the companies (which have continued to stress the production of gas-guzzlers because they are more profitable) to file for bankruptcy if and when they run out of cash, and then undertake the long-delayed restructuring of their businesses under creditor protection, as the airlines eventually did.
It is re-assuring in this context that the authorities here at home have moved carefully. When people argued that non-banking finance companies should not be allowed to fail, the government did not rush in with bailout packages. But the decision to raise the import duty protection available to steel can and should be questioned because steel prices are still too high, by historical standards, and downstream units need lower input costs if they are to cut their own product prices -- as the finance minister has exhorted them to do.

An unusual challenge has been thrown up by the foreign currency convertible bonds issued by companies. With share prices having fallen below the prescribed conversion rates for the bonds, and with many companies unlikely to have the money to buy back the bonds on maturity, the risk of corporate default is high -- and is reflected in the deep discounts at which these bonds are being traded.
There is an obvious opportunity here to buy back the bonds at the discounted prices. Less obvious is the wisdom of the move to finance this by issuing fresh bonds. Such financial engineering must be approached carefully. Spreads on foreign loans have gone up sharply, and will be even greater for companies facing repayment crises and those whose share prices are much lower than before. The net benefit therefore may be limited, and could even be illusory.

The RBI move to reverse an earlier decision that increased the risk weighting for real estate loans is another step that should be questioned. It cannot be that real estate assets have become less risky; although prices have come off their peaks, there are few transactions in the market and all indications are that prices need to dip further.
It is understandable that the RBI might want credit to flow into a frozen real estate sector, but risk needs to be correctly priced if banks are not to be placed at risk. The risk weighting for loans to farmers and to small and medium enterprises has also been lowered -- once again, prudential considerations seem to have been made subservient to the desire to address sector-specific issues.
On the evidence so far, banks are not lending to the troubled sectors because they have their own commercial judgment with regard to risk; indeed, lending rates in the market have dropped by much less than the RBI's benchmark rates, so the problem is that bankers are still careful about the quality of assets they take on.

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Turn off the TV, calm yourself

Panic is a wild, irresistible fear that spreads through crowds like an epidemic.

Panic. Panic is a wild, irresistible fear that spreads through crowds like an epidemic — and it may be upon us now, with day after day of multi-hundred-point swings in the Dow. The word itself seems almost primeval; it derives from Pan, the goat-headed god of shepherds and flocks in Greek mythology, who was believed to startle people with outbursts of mysterious music in frightening places such as steep mountainsides or dark caves.

Fear is a defence mechanism. It bursts forth in our brains the instant we sense that we, or others near us, are threatened. When fear leaps from one person to another, it turns into panic.
You can catch other people’s emotions as easily as you can catch a cold. In an experiment by neuroscientist Elizabeth Phelps at New York University, people either watched someone else get a mildly painful electric shock or suffered the shock themselves. Their brain responses and their dread before the shock were highly similar in both cases, suggesting that seeing another person’s fear is all it takes to make us afraid. Even encountering the circumstances under which the other person was shocked is enough to trigger your own fear.
Viewed this way, today’s financial markets — in which tens of millions of investors watch each other’s fears unfolding in real time on television as well as online — constitute one giant panic transmission machine.
Research at the University of Toronto shows that in a panic, your eyes widen, your eyelids rise and your eyebrows shoot up, making you hypersensitive to any threat that might come from above.
As you look up at a wall-mounted TV screen, wide-eyed to catch the latest news, you mimic the physical posture of fear. That action may, in itself, make your brain more sensitive to negative titbits of news — and more anxious to act on them.
Meanwhile, the sight of someone tensing up in fright not only triggers the fear centre in your brain but also prepares your muscles to strike the same pose. Thus, like soldiers or policemen on patrol in a danger zone, investors are now abnormally “trigger-happy”, because panic has tensed their muscles for instant defensive action.
Fear also changes the way you think, reducing your ability to solve problems creatively, making you reluctant to consider a wider set of choices and causing you to distrust others. That means you are now unusually prone to acting on a gut feeling, instead of thinking.
With panic pervading the markets, every company’s assets may seem worth less now (even professional accountants, when temporarily frightened, will value a business’s inventory at a 10% discount). And you may be inclined to shun anything unfamiliar, like international or emerging markets’ stocks. Yet the underlying value of most businesses does not hang on what happens in the stock market, and many stocks overseas have become even bigger bargains than US shares.
You cannot brush panic away with willpower alone, but you can quarantine yourself from contagious settings:
Break the circle
Instead of socializing with other investors nursing their losses, hang out with folks who do not obsess over the market. You are less likely to be spooked by dilated pupils, grim faces and quavering voices.
Turn off the tube
The sight and sound of screaming traders with fear in their eyes is enough to fill you with fright, whether you are conscious of it or not. If hitting the mute button won’t suffice to calm you down, turn off the TV.
Think positive
When Warren Buffett feels his blood pressure rising or his nerves on edge, he calms himself down by gazing at snapshots of his family or playing a game of bridge with his friends.
Stick to it
Set yourself the simple, stark goal of investing more money in something you don’t want to own. You may need help fighting your fears, so visit www.stickk.com and make a public commitment to your future action. Buying a stock fund next week is mentally easier than buying it today — especially if you recruit some friends to cheer you on.

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Why being a copycat investor can hurt you

While some investors are trailblazers and do their own research, many investors attempt to mimic the portfolios of well-known investors, such as Warren Buffett of Berkshire Hathaway, in the hope of being able to cash in on those investors' world-class returns. But copying another investor's portfolio, particularly an institutional investor's portfolio, can actually be quite dangerous. So, before you jump on the copycat bandwagon, get to know the pitfalls of this approach to investing.

An inability to adequately diversify holdings

It is not uncommon for a major institutional investor, such as a mutual fund, to own more than 100 stocks in a given portfolio. Even Berkshire Hathaway (Warren Buffett's investment vehicle), which has a tendency to invest in fewer stocks as opposed to more, owns shares in some 38 (as of June 30, 2008) different public companies!

Institutional investors like Warren Buffett are able to spread their risk over a number of companies so that if one particular company, sector, industry, or even country hits a rough patch, there are other investment holdings that may pick up the slack. Unfortunately, most individual investors have neither the funds, nor the financial wherewithal to ever achieve such diversification.
So what do investors do when they realize that they cannot maintain as many positions as an institutional investor?Usually, the individual investor will copy or mimic a small portion of the institution's holdings (that is, heavily invest in some holdings and ignore others entirely). Unfortunately, this is where trouble can occur - especially if one or more of those core holdings heads south.An individual investor's inability to adequately mimic an institution's diversification profile and mitigate risk is a major reason why many individuals fail to outperform major mutual funds - even if they maintain similar holdings.

Different investment horizons

Many people like to refer to themselves as longer-term investors, but when it comes down to it, most investors want to see results in the first 12 to 24 months that they own a particular stock.

In fact, according to an often-cited November 2001 study by Gavin Quill (a senior vice president and director of research studies at Financial Research Corporation, a financial services research and consulting firm), mutual fund holding periods in 2000 were only about three years! That is well shy of the more than 30 years that Berkshire Hathaway has owned shares of Washington Post Company. In other words, on average, institutions seem to have much more patience than their individual-investor counterparts do.

In short, even if individual investors achieve diversification similar to the institutions they are looking to mimic, they might not be able afford or have the patience to sit on a given investment for five or 10 years, as they may need to tap into the funds to buy a home, to pay for school, to have children or to take care of an emergency situation, and doing so may adversely impact their investment performance.

Institutional knowledge/research

In spite of regulations meant to level the playing field between individuals and institutions (such as Reg FD, which outlines a company's disclosure responsibilities), institutions often employ teams of seasoned industry analysts. These trained experts typically have many contacts throughout the supply chain and tend to have more frequent contact with a given company's management team than the average individual investor.Not surprisingly, this gives the institutional analysts a far better idea of what is going on at a company or within a given industry. In fact, it is almost impossible for the individual to ever gain the upper hand when it comes to such knowledge.This relative lack of knowledge about future earnings potential, opportunities for growth, competitive forces, etc. can adversely impact investment results. In fact, a lack of knowledge is another major reason why many individual investors tend to underperform mutual funds over time.
This is compounded by the fact that analysts can sit and wait for new information ,while the "average Joe" has to work and attend to other matters. This creates a lag time for individual investors, which can prevent them from getting in or out of investments at the best possible moment.
Keeping tabs on institutions is tough

Even if an individual has enough money to adequately diversify him- or herself, the willingness to hold positions for an extended period of time and the ability to accurately track and research multiple companies, it is difficult to copy the actions of most institutions.Why? Because, unlike Berkshire Hathaway, many mutual funds buy and sell stocks with great vigor throughout a given quarter. In fact, take T. Rowe Price as an example. According to the company's website, its Capital Opportunity Fund (which invests primarily in domestic securities) has a turnover rate of 63.5 as of July 31, 2008. That's big. This makes positions like these are hard to mimic because even if you had access to databases that track institutional holdings the information is usually updated on a quarterly basis.What happens in between? Frankly, those looking to mimic the institution's portfolio are left guessing, which is an extremely risky strategy, particularly in a volatile market.
Trading costs can be huge, and treatment may vary

By definition, institutions such as mutual funds have more money to invest than the average retail investor. Perhaps not surprisingly, the fact that these funds have so much money and conduct so many trades throughout the year causes retail brokers who service these accounts to fawn over them.Funds often receive favorable treatment. In fact, it's not uncommon for some funds to be charged a penny (or in some cases a fraction of a penny) per share to sell or purchase a large block of stock - whereas individual investors will typically pay 5-10 cents per share.In addition, even though there are rules to prevent this (and time and sales stamps that prove when certain trade tickets were entered), institutions often see their trades pushed ahead of those of retail investors. This allows them to realize more favorable entry and exit points.In short, the odds are that the individual, regardless of his or her wealth, will never be able to garner such preferential treatment. Therefore, even if the individual was able to match an institution in terms of holdings and diversification, the institution would probably spend fewer dollars on trades throughout the year, making its investment performance, on a net basis, better overall.
Bottom Line:While it may sound good in theory to attempt to mimic the investment style and profile of a successful institution, it is often much harder (if not impossible) to do so in practice. Institutional investors have resources and opportunities that the individual investor cannot hope to match. Retail investors may benefit more, in the long run, from an investment strategy more suited to their means.

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Indian banks capitalise on Wall Street crisis

Compared with its Wall Street rivals, India's Ambit Holdings has long been considered small fry.
Launched in 1988, the Mumbai-based investment bank has just 180 employees. With the financial crisis engulfing the big Wall Street firms, though, Ambit executives want to grab the opportunity to gain ground on their better-known competitors.
Over the past year and a half, Ambit has expanded into wealth management, private equity, and insurance brokerage. The expansion has helped it emerge as one of the top five banks in the Indian league table.
Ambit's biggest coup came on Sept 15. That's when it announced it had poached Andrew Holland, head of the strategic risk group at DSP Merrill Lynch, the Indian joint venture that Merrill operates.

Holland brings with him a four-member proprietary trading team.
Ashok Wadhwa, chief executive of Ambit, claims he had been negotiating with Holland for the past three months, and the news surrounding Merrill's shotgun acquisition by Bank of America did not force anyone's hand.
However, the bad news didn't hurt, either. "The financial crisis couldn't have come at a better time," he says.
Other Wall Street refugees are finding their way to Ambit.
In August, Wadhwa appointed Nikhil Puri, from Bear Stearns' New York office, as managing director of Ambit's corporate finance business.
Now, Wadhwa says, Ambit is in final talks with a handful of Lehman employees.

A boost for India brokers
Wadhwa isn't the only one hiring. Over the last year, the subprime crisis in the US has provided a major boost to Indian brokerage houses.
With employees worried about the stability of US and European banking giants, local rivals have been poaching talent from their big Western peers.
Homegrown Indian banks have been luring institutional brokers, wealth managers, and asset management professionals at foreign banks, with employee stock options and a share of profits.
What made it easy was the booming stock market, which yielded returns of more than 40 per cent, a growing group of wealthy Indians, and high consumer spending.
Executives from some of the biggest names in banking have been making the switch. For instance, HSBC saw its five-member India equity sales team defect to Mumbai-based brokerage firm Antique Stock Broking in December.

More than five Citi bankers moved to local financial-services firm Anand Rathi Securities in February of this year.
Now, Reliance Capital (the financial-services arm of the Reliance ADA Group), JM Financial (one of the oldest investment banks with the Tata Group as one of its major clients), and local financial-services shops like Kotak Securities, Enam Securities, and IDFC SSSKI Securities are waiting to scoop up talent in institutional brokerage, wealth management, and mergers and acquisitions.
"There's a great deal of talent available, and a ready-made setup for any startup," says Narayan SA, managing director of Kotak Securities.

In a way, the Indian banks have come full circle.
Over the years, as part of the constant employee churn, they've watched their staff desert them for foreign banks, attracted by better paychecks and a global environment in which to operate.
"It's a great learning experience and puts you on a different level altogether," says a banker who returned to an Indian firm.
Just last year, Kotak lost people to Credit Suisse.
JM Financial saw its business split and people move when it parted ways with former partner Morgan Stanley in early 2007.
The defectors are now returning, as the Wall Street crisis is drawing Indian bankers to safer havens in local firms.

Long-term strategy
Even today, India is still a great investment destination, say bankers, despite its slowing economy (which has skidded from 9 per cent growth last year to 7.5 per cent currently).
The 30 per cent drop in the Bombay Stock Exchange Sensex since January this year, and a slowdown in M&A activity that followed, may be dampening enthusiasm in India's financial sector, but other services such as wealth management, advisory, and private equity continue to do well.
"The current expansion is only an indication of our long-term strategy," claims Anand Rathi, who heads a firm of the same name. He says he is now negotiating with bankers from Lehman, Merrill, and Goldman Sachs.

Also getting ready for market conditions to perk up is Reliance Capital, with a business portfolio that includes asset management, insurance, private equity, proprietary investments, brokerage, and consumer finance.
It plans to enter investment banking, which its CEO Sam Ghosh says "was the missing link in the chain" to become a full-fledged financial-services provider.
Some key Lehman India bankers claim that they received calls and offer letters from Reliance early this month.
Keshav Sanghi, a former head of equities at Deutsche Bank who is now CEO at Reliance Equities International, won't comment regarding possible hiring but adds "we are always on the lookout for people."

A big clincher is the global experience of those at the Wall Street banks.
Indian brokerages can draw on their own India know-how but are weak in institutional equity sales, since Western banks dominate most of the foreign institutional investor business.
"People in global firms have the ability to engage with clients, have global experience in running a shop better, and are well versed on products like derivatives," says Vallabh Bhanshali, chairman at Enam Securities.
That's why there's a scramble to hire them. With Wall Street collapsing, there are so many of them, Kotak's Narayan says, "We are spoiled for choice."

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