Questionnaire - 19/05/15 20:54 / 1

While everyone lauds Buffetts strategy of buy and hold, rarely does anyone follow it. Practically speaking, how difficult is the buy and hold strategy, especially in the Indian context?

If you pick 100 people who have really done well in stocks over a decade or more, youll find that the vast majority of them are buy and hold investors. There will be very few successful traders in that group. The odds are quite clear. A buy-and-hold strategy works much better than a strategy involving jumping from one flower to another like a butterfly.

Why do most stockmarket investors behave like butterflies? Its a fascinating question. The answer, in my view, lies in several psychological forces.

One big reason why investors jump around like butterflies from one stock to another is that they feel confident that the new flower will be much juicier than the old one. If they didnt have that feeling why would they jump? But it turns out that in the vast majority of cases the investor butterflies (not the real ones) are overconfident. We know this because of several studies done on millions of brokerage accounts. These studies show that people who trade the most (the butterflies) do much worse than those who trade the least. Actually, some of the best track records came from those of dead people.

Investors should listen to Buffetts advice: The stock market serves as a relocation centre at which money is moved from the active to the patient.

Another big reason why people sell is that they see gains and they are petrified of losing them. Charlie Munger calls this Deprival Super Reaction Syndrome. For most people, the pain quantity of pain derived from a Rs 1,000 loss is much more (about two and half times more) than the quantity of pleasure derived from a Rs 1,000 gain. And people are not only petrified of taking losses (which is why they refuse to sell when stock prices fall below their cost) they are also petrified of losing potential gains. They start getting feelings like: Its gone up so much! How much more can it go up now? Or they start listening to brokers who tell them: You cant go broke taking a profit. They forget that whats good for the broker activity is bad for them. When they ask their brokers for advice on profit taking, they are, in effect, asking the barber if they need a haircut.

The third big reason why people fail to follow a buy-and-hold strategy is that very few people do it. We are social animals and are deeply influenced by how other people behave. If everyone is taking profits and jumping to the next flower, you want to do it too. Its a basic human tendency. One of the least known tragedies of fund management is that the majority of the investors in the best performing funds lose money. Why? Because they chased performance blindly. And they did it largely because everyone was doing it.

The fourth reason why people resemble butterflies is because of the presence of a pleasure chemical called dopamine in our brains. The more the dopamine the more the pleasure. And novel experiences (imagine bungee jumping or a one-night stand) deliver enormous amounts of dopamine to the brain. The other thing that delivers dopamine is

Questionnaire - 19/05/15 20:54 / 2

unexpected, pleasant surprises. And day traders get a lot of small, but pleasant surprises just like kids who are hooked to gaming. It gets addictive, this dopamine business. The more you get the more you crave for. If you put a day trader who just had a winning bet in a fMRI machine and compare him with a cocaine addict, the doctors cant tell the difference. Their brains look just the same. Behaving like a butterfly increases the probability of novel experiences. It increases the probability of small, unexpected surprises. Warren Buffett has written that for many investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be. He is clearly on to something. True wealth is created by buying something boring and very profitable at a reasonable price and then holding on it for a long long time. Its as boring as marriage, as Keynes said:

The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave causes, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.

Is it possible to find gems/stocks that investors can hold on to for a lifetime. Could you give a few examples of the same.

Yes its possible but its not easy. It requires effort and a lot of hard work. Its not very complicated but it requires focus and hard work. If investors are willing to do that, they can stop behaving like butterflies and start behaving like sensible, long-term investors.

I wont like to give examples because I dont want to talk my book here. You can just run a screen of businesses that delivered exceptional long-term returns to investors over the last 10 or 20 years. It will not be a small list. And there will be lots of common elements in them like the presence of a good business, the presence of a great management and a reasonable price at the time of purchase

What, according to you, can be considered long- and medium-term in the market? What is the ideal time investors should stay in the market - what factors determine the staying period?

If youre buying a high-quality business which will compound capital for a long long time, the time to sell it, according to Philip Fisher, is almost never. Thats what buy and hold really means, doesnt it?

I think its a big mistake to use equities as a short-term asset class unless you are doing some specialised operations like risk arbitrage.

Which are scenarios/situations that investors can look to exit and/or book profits? Are there any particular strategies that investors can follow?

Questionnaire - 19/05/15 20:54 / 3

When you follow a buy-and-hold good quality business strategy, then you should sell if the quality of the business is impaired or is likely to be impaired, or of the quality of the management is seriously impaired or if the valuation is so extreme that even under optimistic scenarios the money to be made over the next five or 10 years is mediocre at best.

Has buy and hold become more difficult to implement in the last ten years (because of increased volatility as our markets are more closely connected to global markets, fewer opportunities to spot companies that can grow over a lifetime) Why?

Look, making enormous amounts of money in the stock market was never easy and never will be. So if investors are looking for making a quick buck, they have come to the wrong place. Market conditions will continue to change, as they have over the last several decades, but the formula of buying good businesses run by good managements at reasonable prices will continue to deliver great investment results in the long term. I believe that very strongly and when you listen to me on that, keep in mind that you are asking the barber if you need a haircut.