Last session, we learnt that timing is not a key factor for making money in the stock market. Sure, the returns do go up when you time as well as Mr. Timer. But then you need to be quite a genius, to be able to time as well as him. If not, I am afraid that it requires a lot of time and effort and even then there are no guarantees that you will be as successful as Mr. Timer. It’s very likely that you might get left out like Mr. Waiter. The key to returns in this market is steady investment. This week we dig deeper into this issue. Let’s see what we unearth.
In defense of timing
Many of you who are in the business of timing the market might not have appreciated our analysis (of course, being told that they earned only 31.8% more than the steady investors in HLL over a 9-year period hasn’t exactly endeared us to them!). They argue that HLL is the wrong example to use for this argument. The extra returns earned by HLL are not high because the stock’s long-term trend has been in the upward direction, they contend. They believe that the premium earned through timing is far higher for stocks that have not been in a secular uptrend (which are more range-bound).
Is there any truth in this contention?
To find out, let’s consider a big cyclical company—Reliance Industries Limited (RIL)—and rework the investment returns of Mr. Timer and Mr. Orderly.
How different are returns on a cyclical stock?
As you read last week, Mr.Orderly had invested Rs100 in HLL stock on the 5th, 15th and 25th of every month since January 1991. Let’s assume that he had invested in Reliance instead. Then, on selling all his stock (worth Rs31,500) on September 30, 1999, he would have received Rs63,216. His return on investment—100.69%.
Assume also that Mr.Timer, that old master at finding the bottoms, started investing Rs300 in RIL every month beginning January 1991. By selling the RIL shares on September 30, 1999, he would have earned a return of 120.89%.
So there you have it. While steady investment in RIL over the Jan1991-Sep1999 period yielded a return of 100.69%, timing the investment earned an extra 20.2%.
Mr. Timer did fare better with Reliance
Over the nine-year period, Mr.Timer earned 20.2% more than Orderly on the same investment. The figure does substantiate Mr.Timer’s argument that the premium derived from timing a stock is higher for range-bound stocks as compared to stocks like HLL, which show a long-term uptrend. If you remember, on HLL, Mr.Timer made a return of 473.75% over the 9-year period while Mr.Orderly earned 441.93%. In other words he earned an extra 31.82% for his efforts, a measly premium of just 6.7%. On RIL, on the other hand, Timer has earned a premium of nearly 20% as compared to Mr.Orderly’s returns.
So -Yes, Mr.Timer did do much better with Reliance than with HLL
What if they take exposure to both HLL & RIL?
No investor keeps all his eggs in one basket. Diversification is the best ‘mantra’ of any prudent investor. So, let’s create a portfolio consisting of both HLL and Reliance.
Let’s assume again that Orderly invested Rs100 on 5th, 15th and 25th of every month starting January 1991, but that he spread his investment over two stocks—Rs50 in HLL and Rs50 in RIL. On selling his stocks on September 30, 1999, Orderly would have received Rs125,527 this time around—an impressive 298.50% return on his investment.
Now let’s see how Timer would have fared in this scenario. He would have invested Rs300 per month in an equally weighted portfolio of HLL and RIL over the same period, the difference being that he would’ve identified the bottom levels of both stocks every month. His investment would’ve earned him a return of 321.55%.
What does that mean? Well, the bottomline is that Timer, for all his expertise in timing, ends up earning a premium of just 7.87% over Orderly’s returns. A measly 7.87% for all that effort!
How do things change in a diversified portfolio?
Obviously, in real life any long-time investor can be expected to have at least 10-12 stocks in his portfolio. For the purpose of diversification, let’s assume that these 10-12 stocks will be of different kinds. Some would be like HLL, an Evergreen stock, and some would be cyclicals like Zuari where there is much more money to be made by timing. In other words, the contribution of timing in such a portfolio would be somewhere in between the two extremes, perhaps to the tune of the premium earned by Mr.Follower (remember him?).
In a good and managed portfolio, however, the timing factor gets marginalised. In such a portfolio, the returns earned by Orderly are likely to beaten by only the slimmest of margins by Timer.
And in real life, because we often fail to catch the bottom (like Follower), there is a big risk that we could end up with money in our bank (like Waiter) even as the stocks we want continue to gallop higher.
The key to making money in the market with the least amount of effort involves just two simple steps. First, and the most important, is steady investment. The other is investing in a portfolio. By following these two steps, you will not only make money but your returns could even match those of Mr. Timer. Happy investing!
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