Friday, January 15, 2016

Gandhiji's three stock market monkeys

There are three possible financial position you can be in while playing the investment game. Partially invested, fully invested, and leveraged. Partially invested means you have some cash and some investments. Fully invested means you have deployed all your cash into investment instruments and have no more cash left on hand. Leveraged means you have fully invested all your cash and you have borrowed additional money for investments. There is another type with zero investments and full cash. We ignore these people because they are not impacted in any way by the market. Now let's look at what will happen for these three type of investors in different market situations.

Bull market
Maximum gains will be made by the leveraged investors, followed by fully invested, followed by partially invested. Leveraged investors are on an accelerated & dangerous path to riches, fully invested people are on a fast and risky path to riches and partially invested people are on a slow and steady path to riches.  But all will gain so no problem here, all good.

Bear market
Partially invested people are in a sweet spot. They won't loose much and at the same time they have cash to take advantage of the market fall. Usually the strategy should be to never run out of cash and to deploy it slowly into the market when the market is in the grip of fear and panic and is offering great bargain hunting opportunities. Off-course this will lead to depletion of cash reserves which should be replenished once the market recovers so that it can be used for the next cycle.
Fully invested people are in a tight spot. They will be suffering huge mark to market losses on their investments and won't be able to take advantage of the market fall also because they have no investment cash reserve for rainy days. In the worst scenario they can loose all their investment value and be left with a near-zero networth. This is still not as bad as the third category.
Leveraged people will be suffering losses multiplied by the times they leveraged themselves. They run the risk of not only losing their entire networth, but on top of that owing money to others that they will have to pay back or face extremely severe consequences. Market mechanics are designed such that during bad times you have to payback immediately and during good times you can keep on adding more leverage. A dangerous and poisonous cocktail guaranteed to kill you if overdosed. This is the dangerous part. Extreme cases will suffer bankruptcy, harassment, legal trouble, depression to start with and things could get much worse.



for partially invested people
You are in a fine spot. Just keep calm and play the market fall wisely and you will come out of this phase much stronger. "Wisely" is the most important word here. Make sure you retain the edge you have. If you are inexperienced in dealing with bear markets, don't do it on your own. Seek expert guidance.

for fully invested people
Try to lighten up if possible. If not, you have to take a break from the market and focus on new earnings and build up your cash reserve again. Out of cash is out of game. You will have to take a slow and patient path to recovery.

for leveraged investors
Seek help. Act quickly. Close all leveraged positions, book your losses, try to minimize it as much as possible. If you need, seek help from near and dear one's, else you will be in so much trouble that there will be no path to recovery left. You need to act urgently and be prepared for a really long and painful path to recovery.


No comments:

Post a Comment