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Busting small investor myth

india Updated: Jan 15, 2007 15:25 IST
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There seems to be a school of thought around that the stock markets must run in such a way that the so-called retail investor must always make money, and if he doesn't, then there is something wrong. Either the laws are inadequate or the markets are crooked, or preferably, both. This belief surfaces most strongly when- ever an IPO opens at a discount, as happened last week with Cairn Energy.

The belief that the retail investor (formerly called the small investor) has a right to make profits no matter what he does, is shared by some in the investment community, the media and in the government. There are frequent lamentations about the fact that the retail investor is not participating in the markets and various remedies are suggested (and some implemented) to correct this supposed anomaly.

In fact, 2005’s IPO scam was essentially about large investors going to absurd lengths to disguise themselves as small investors in response to the IPO lottery being fixed to favour the latter. Am I saying that no individual should invest directly in stocks at all? After all, expert investors too start out as individuals investing for themselves.

The way it happens is that a large number of investors try their hand at the markets, usually when the markets are booming. As long as the markets stay strong they all make money, more or less. This makes them confident so that when the bulls stop running, most of them lose heavily. Some, however, turn out to have the right mental make-up for this activity and go on to become experts. There is nothing wrong with this.

Markets are inherently Darwinian and it is in their nature that those who make the wrong choices will lose. For a market to function correctly, those who make the right choices must make money those who make the wrong choices must bear losses. If we see this as a problem and try and fix things, we will actually end up breaking them.

I think this idea of the small investor participating directly in the stock markets needs to be fundamentally re-examined. Trading profitably in stocks on a sustained basis is a specialised skill that is not easy to acquire or practice. This has always been true in all stock markets regardless of whether those markets are well-regulated or not or whether they are crookedly or ganised or honest.

Those who promote the idea that everyone can buy and sell shares and make money with any certainty basically end up leading a lot of lambs to eventual slaughter. For the small investor, the only safe way of participating in the markets is in directly, through a mutual fund or some similar structure where their money is being managed by someone else who has a good track record that is transparently known.

Stock investing is an increasingly complex activity. At a time when Indian business are evolving so rapidly, the kind of commitment of time and effort needed to research things adequately can probably not be made on an parttime basis.

I'm not saying that no one can do this but being an informed investor takes either a professional-scale commitment or an accidental instinct. There's no guarantee that any given investor can do this. It's time to lay the myth of the small investor to rest.

The writer is chief executive of Value Research India

E-mail Dhirendra Kumar: dhirendra_kumar@ valueresearchonline.com

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