The 20/20 Rule

After a substantial decline in the market, investors usually follow a wait and watch policy to re-enter the markets. Actually they wait for a reversal of the trend. However, generally investors keep waiting for a conformation of trend reversal and in that process lose opportunities of money making as markets move up substantially. Then these investors are left with no option but to invest at expensive and overheated levels. What then should be the strategy followed by investors to make money in the markets. We outline a simple rule which if followed will always make you wealthy without too many worries.

Rule is ‘Always leave 20% for other investors’

Nobody has been able to time the market accurately and with consistency. Wise investors always take bold decisions and go against human psychology. In bear markets you reach points of extreme pessimism when everyone is fearful. During such periods everyone feels reluctant to buy as there could be more   downside to the prices.

A savvy investor argues that if there was no downside left there would be no sellers left and it would be impossible to buy. Hence after buying he is prepared to see some more downside in the near term in return for a fabulous upside that will follow as and when the sentiment reverses. Similarly when the going is very good it is very difficult to sell as one is confident of more upside to the markets. On applying the same logic that there will be buyers only when there is more upside available, a savvy investor sells his portfolio and is prepared to offer the balance upside potential to other investors.

Analyze the BSE charts for the last twenty years. Markets go up and down by at least 50% every two years. In fact in the last five years they have gone up or down by at least fifty percent every year.

Now let us understand how this rule works with the help of an example. Assume that the markets were to go up or down by at least fifty percent in two years, something which has nearly always happened in the past two decades. Also each time you were to buy in a bear market you were to see a further twenty percent fall in values and when you sell after making good returns and seeing optimism all around, the markets were to rally by another twenty percent. You would still end up with at least 15% annualized returns every year. This would be without any stock selection required and also no great market timing skills. Simply, following the twenty-twenty rule and being greedy when others are fearful and fearful when others are greedy.

In real life your returns will nearly always be more than 15% every year and that too without any significant research, tension or effort required. Needless, to say that if you were to select stocks prudently, which beat the BSE Index, your returns would be significantly higher.