As a financial planner one question that is repeatedly asked to me nowadays is “should I invest in markets now or wait?”. Therefore I have tried to answer the question in this article.
First, I would like to analyze what this question is all about. Why this question is asked now, since last 2 months and especially post election results? When I try to analyze, I find two aspects of this question in the mind of investors which are as under.
1. Isn’t market very high at 24000 levels?:
Primary question that is there in the mind of investors is “Isn’t market very high at 24000 Sensex levels?” Investors are comparing current levels of market with Jan-2008 peak level of 21000 and considering that the market is very high at 24000 levels. Investors have a general understanding that since the market dropped from 21000 levels in Jan- 2008 in last market cycle and currently it is much above that level, therefore the market is very high at the moment.
Let me tell you this is a wrong way of comparison. Just go through following chart.
|Earning Per Share
What is Earning Per Share?:
First understand this by a simple example. For instance, there is a company which has issued 100 shares and has earned net profit of Rs. 1000. In this case Earning per share would be Rs. 10(Earning per share= Net Profit/no. of shares issued)
Similarly Sensex is an index of 30 large companies of India. Earning per share of Sensex is arrived at by dividing the net profit of these 30 companies by total no. shares of these 30 companies combined together.
In above chart you can clearly see that in Jan-2008, when Sensex was above 21000 levels Earnings per share that is net profit per share of Sensex companies was Rs.750 per share. So Sensex was trading at around 25 times of earnings per share. However, currently at 24000 levels, Earning per share of the Sensex companies is at around Rs. 1293 per share. So it is trading at around 19 times of the earnings per share. Therefore, between Jan-2008 and May-2014 earnings of Sensex companies have gone up from Rs. 750 to Rs. 1293 that is around 72%. Whereas Sensex has gone up from 21000 to 24000, that is around 15%. So relatively Sensex is cheaper or undervalued than Jan-2008 levels.
2. Should I wait for markets to fall?
When I explain that markets are not costly and they are undervalued then Second aspect of this question is related to market timing. Here most of the investors want to know whether markets will fall from this level and will be available at lower level or not. This question arises because investors think that a qualified financial advisor is able to predict the markets and should be able to point out bottom or peak of stock market. But this is not true, predicting peak or bottom of the stock market is not possible so investors should not try to do this. Ratio analysis can only tell us whether markets are overvalued or undervalued, but it is not possible to predict whether markets will go up or fall down from this level. So investors should not try to time the market.
Then What should Investors do?:
Investors should try to strategies their investments as per their investment period. Investors should ideally divide their investments into Short term and Long term as per their investment objectives.
Short Term Investments: Money which is required within 5 year is actually short term and here you should not invest much in Equity market. Typically, money which is required in next three years should strictly be in safer asset classes like bonds. Money which is not required for next 3 years but required up to 5 years can be invested up to 20% to 30% in equities and rest in bonds. In short term market, volatility is major risk and investors should avoid taking this risk because if markets fall at the time when you need money for your objectives than you will have to book losses.
Long Term Investments: Money which is not required for next 5 years should be invested more in Equity markets. Exactly How much money should be invested in equity markets depends upon three factors
- Your need to take risk: This means how much rate of return you need to earn to achieve your goals.
- Your ability to take risk: This depends upon different factors like your age, type of income, number of dependents etc.
- Your Willingness to take risk: Willingness to take risk means your psychological comfort level with volatility.
Investors should discuss these three factors with qualified financial advisors and finalize their allocation to equity markets and bonds for long term and then keep re-balancing their portfolio at regular periodic intervals to manage their risk.
To conclude with, investors should not get confused with mere market levels, they should focus on valuations by understanding growth in profits of companies and most important they should focus on their investment horizon rather than market timing.