Lessons from the yesterday’s market crash and today’s rise

The fall since October and the more than 2,000 points recent fall of the Sensex has left many retail investors baffled. They were told that the stock market could only go one way, and that is up. 

Take a look at the accompanying chart. It plots new demat accounts opened every month (on the left-hand side) and the level of the BSE Sensex (on the right-hand side).

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What does the chart tell us? It tells us that from April 2020 onwards, as the Sensex has gone up, so have the number of new demat accounts being opened every month. In fact, in October, when the Sensex peaked at 61,766 points, so did the number of new demat accounts opened during a month at 35 lakh accounts. 

It tells us very clearly and all over again that many retail investors enter a bull run very late in the day after they have seen others make money. This explains that those who entered the market in September must be largely sitting on losses as of now. Let’s call them the outsiders. 

The outsiders bought the story being sold by the insiders. Insiders are people who make money through the business of stocks, that is, the fund managers, the analysts, the stock brokerages, the portfolio management services, and so on. They make money when they keep investing more and more money. Hence, their incentive is to keep saying that the stock market will keep going up to keep attracting more and more money and increase their assets under management and hence, the money they earn. Of course, this is not to say that every insider does this, but many do. 

Every fall is a buying opportunity, and every rise is an indicator that the rise will continue. And this does happen for a while until it doesn’t. Like was the case over the last two days, when many retail investors found out that a stock market could fall as well. There is a whole generation that hasn’t seen a bear market. And the lack of that experience can be telling. 

The fall made many outsiders philosophical. Many were shocked to say anything. Still, others thought that they were long-term investors. Most people don’t get that serious long-term wealth cannot be built in such a random way of waking up every morning and then figuring out what we should do with our money today. 

As Morgan Housel writes in his excellent book The Psychology of Money: “There are universal truths in money, even if people come to different conclusions about how they want to apply those truths to their own finances.”

One universal truth is asset allocation or diversification or not putting all your eggs in one basket. Hence, it makes sense to spread your money across asset classes, everything from stocks to real estate (if you can afford it) to gold to fixed deposits (yes, you heard that right). 

No one knows with any certainty what will happen to stock prices tomorrow morning or one year down the line or ten years down the line. The confidence that they project comes with their job of making money through the business of stocks. In the past, the world has seen bear markets which have run into decades. At the same time, there have been bull runs as well, which have gone on for decades. 

The only way to seriously play this is to spread your money out so that if a particular asset does well, a portion of your money benefits from it, and at the time, if a particular does not do well, your losses (or the lack of gains) are also limited. 

So, every outsider who made some money in 2020 and 2021 and became a guru who thought investing in fixed deposits is a waste of time because the interest rate on offer is lower than the inflation or the rate of price rise, well, it turns out fixed deposits still make a lot of sense, simply because the return of capital is more important than return on capital. 

Of course, diversification has its share of costs as well. Everyone who ensured that a part of their savings continued to be invested in fixed deposits in the last two years to preserve what they had already built had to pay a cost for it in terms of lower returns.

But at the end of the day, everything depends on what money means for you. To me, it means independence to make the decisions that I want to make. In the last 18 months, I have tried to protect what I have built more than earning a return on it. This is simply because I couldn’t handle uncertainty in income being a freelancer, uncertainty on the covid front and economic uncertainty, all at the same time. In that sense, our investing situations are unique. But the point is that most outsiders seem to understand this very basic fact and do what the insiders tell them. 

As Housel puts it: “We can leave aside rich, but independence has always been my personal financial goal. Chasing the highest returns or leveraging my assets to live the most luxurious life has little interest to me. Both look like games people do to impress their friends, and both have hidden risks. I mostly just want to wake up every day knowing my family and I can do whatever we want to do on our own terms. Every financial decision we make revolves around that goal.”

As far as universal money lessons go, this is a pretty good one. Oh, but does it really matter because stocks are up again today.