Tuesday 10 April 2012

Contrarian Investing

I read this article today and it really got me thinking.


I was particularly astounded by the statement that - 'during the period 1984-2002 -- a bull market when the equity markets turned $100 of spending power into $500 -- private investors succeeded in turning that same $100 into just $90.'

What? They lost money!? How could they when invested through such a bountiful era? I dread to think what returns these people have made (lost!) in the hard times since 2002.

The general mass of private investors by their very nature are anti-contrarian. They are doomed to buy at the peak of the market, buy into fad sectors that are grossly overvalued and they end up losing a fortune as bubbles pop and markets correct.

'Buy low, sell high', it sounds so easy doesn't it? In reality it is very hard as it involves overriding our feelings of greed and fear.
In the super market when prices of a certain product fall, people act rationally and buy more, possibly even stockpiling if they have the facility. In the stock market though, when prices fall people get scared. They lose faith in their investment and often sell out and stuff their money under the proverbial (or actual) mattress. This being exactly what they shouldn't do. If anything they should be buying more.
If they thought XYZ plc was a good buy at £2.00 a share, surely if they fell to £1.00 a share they would want to buy more? This is rarely the case, and is the main reason why the average investor is doomed to under perform the market.
As Warren Buffet says - 'Be greedy when others are fearful, and be fearful when others are greedy'

To understand when the market is cheap, as active investors we must familiarise ourselves with valuation measures like P/E ratios PEG ratios, Dividend Cover and Net Asset Value (NAV) so that we might determine when companies are ripe for investment.

If you are a passive investor your chances of success can be increased by making regular payments into a fund, thus negating your chance of getting the timing wrong, also try not to get scared if your fund is showing a loss, stopping your investment payments would probably be a costly mistake in the long run!