Investing Books

Financial Literacy to become rich

February 13, 2022 by Laxman Sonale 16 Comments

Hello friends, I am Laxman Sonale, In today’s article we see the financial literacy to become rich from chapter 11:- ‘why must one invest’ from the book ” Stock To riches ” by Parag Parikh. In this chapter, you know the difference between rich people and poor and middle-class people’s income, their expenses. The most important how we become rich.

so let’s start

Previous Chapter 10

Chapter 11:- Why must one Invest:-Financial Literacy

In the starting, the author gives a quote on today’s situation.

“Modern man drives a mortgaged car over a bond financial highway on credit card gas.”

– Early Willson

In this chapter, the author talks about the basics of financial literacy. let’s see what he say

the author says, ” I would like to end the book with some thoughts on the paradigm of money and the basic of financial literacy. these concepts are very well explained in the Rich dad, poor dad series authored by Robert T. Kiyosaki with Sharon L. Lechter.

We are afraid of losing money, of not having enough to make. if you have a passion for anything you will accept by passion helps you to think positively. But when you do that you will never have enough money to fulfill your desires.

People believe that money can solve all their problems, but that idea is an illusion.

Remember when you were just out of college. you had certain desires to be fulfilled and certain bills to be paid. so you were thrilled when you got a job. (Financial Literacy)

you believed that the paycheque at the end of the month would solve all your problems when the paycheque arrived you paid the bills for your desires. you were happy about it, but this happiness was short-lived.

As soon as you fulfilled your desires, they increased and you required more money to fulfill your desires. they increased and you required more money to fulfill those new desires.

When you got a hike in your salary the pleasure was again short-lived for your desires increased in proportion to your income.

It’s a never-ending story and you are always afraid that you will never have enough. so every time you think of money fears grips you and you make decisions not with your mind but with your heart.

What you need to do is to change your paradigm. passion should drive you not to fear, think of what you can do with money and what you should do to make it.

money is an idea. you see it more clearly with your mind than your eyes. learning to play the game of money is an important step on your journey to financial freedom.”

after this explanation, then the author talks about learning the money game.

Learning the Money Game:- Financial Literacy

in this point, the author shows how money works for rich people, middle-class people, and poor people.

the author says, ‘ To be a successful investor you must know how money works, there are some elementary facts about finance that unfortunately are not taught in schools and colleges. (Financial Literacy)

so let’s begin, learning now

The question you should ask Yourself: What is an Asset?

Answer:- An asset is that which creates an income for the owner.

see the following image to understand better.

Question: What is Liability?

Answer:- A liability is that which creates an expense for the owner.

see the following image to understand better.

then the author gives the difference between asset and liability with bank examples

author says,” have you been approached by banks willing to lend you money to buy a house? Does your banker say he will help you buy an asset?

Attractive deals in the form of low-interest rates and long-term mortgage payments are offered. so you go ahead and buy your dream house thinking you are buying an asset.

By the definition of an asset, it should create an income for you. however, here it is creating on expense in the form of mortgages, taxes, interest, etc.

so common sense demands that you treat it as a liability rather than an asset.”

then, the author explains, why a banker tells you, a house is an asset.

the author says, ” Yes, the banker did tell you that you are buying an asset. what he did not tell you was that he was buying the asset for the bank and a liability for you.

There is nothing wrong in buying a house and mortgage, but understand that you are thereby creating a liability for yourself that will entail further expenses. even if you buy a house with your own money and kept it locked you should treat os as a liability as you are incurring expenses for its upkeep in the form of maintenance charges, property tax, society charges. etc. (Financial Literacy)

However, if you buy a house on mortgage and rent it, and your rental income is higher than the mortgage, then you have a positive cash flow.

House becomes an asset as it generates an income. Understanding how assets and liabilities work is basic to Financial Literacy.

Your cash flow is an indication of whether you are building assets or taking liabilities. if income is coming in your pocket, you have an asset, if income is going out of pocket, it is a liability.

Once you understand this you can work out your own financial future.”

then the author explains the Cash Flow of middle-class

Cash flow of the Middle-Class People:

In this, the author says, ” A majority of the customers of bank and consumer goods companies come from the middle-class. it is not because of their inherent purchasing power but because they happen to be attractive borrowers.

They are cautious about money yet, as they strive to improve their standard of living they get increasingly into debt. all their lives they work to pay off their mortgages, credit cards bills, car longs, etc.

they start small, like taking a loan to buy a two-wheeler, but soon their desires increase and they want to buy a car. so they go to the bank and take a car loan to fulfill their desire. with a bigger loan, the outgoings increase and they desperately look for a hike in their salary.

the hike comes and with it the desire to buy a bigger car. so the bank offers them a bigger loan. and this goes on and on. expense move and an increase in salary are soon nullified.

Only the liability increase; no-effect is a mode to increase the asset. they don’t realize that they have started working for the bank also ( by taking up liabilities.)

Now they work for two bosses. One who provides the job, and the bank to whom they give the interest, mortgage, etc?

this is the cash flow of the middle-class, which you will understand better from the following image.

As the income of the middle-class increase so does their liabilities.

they make little effects to create assets Instant gratification and financial illiteracy dominate their decision-making. they believe, they are creating assets in the form of houses, cars,s, etc. whereas they are only creating liabilities and increasing their expense. (Financial Literacy)

see the following image to understand middle-class people status quo

What differentiates the middle class from the rich is their lack of financial literacy.

it is the cash flow that makes all the difference the rich understand the power of money and they make it work for them. they always have a positive cash flow.”

then the author talks about the cash flow of the rich.

Cash flow of rich people:-

in this the author says, ” the rich create assets, the assets create income, from they create more assets. even if they buy a house on mortgage, they rent it and the rentals are higher than the mortgage and other charges they pay.

so the house is an asset for them even if they take a bank loan to acquire it. see the following image to understand better way.

the balance sheet of the rich consists of assets like stocks, bonds, real estate, etc.

their income derives mainly from dividends, interest, rental, etc. they make their money work for them and they do not create liabilities.

thus their expenses are under control. anyone can do what the rich do.

Firstly it requires discipline to stay the course and avoid instant gratification of desires.

Secondly, it requires an understanding of the basic principles of assets and liabilities. it’s easy to become financially literate if you have the patience.

some say that money begets money these people should have stayed rich, they lost only because they were not financially literate.

they did not know, how to harness the power of money. To become rich you must have a passion for money. Making money is a game and you must enjoy playing it. It is tough but worth the trouble.”

then the author gives fours ways of making money.

the author says, ” there are four ways by which people make money ad each method forms one quadrant of the income generation circle. (Financial Literacy)

different people fall into different cash quadrants depending upon the source of their cash flow.

Employee cash flow quadrant:- they work for somebody and earn a salary as employees.
Self-employed cash flow quadrant:- they are the professionals like, doctors, lawyers, architects who are self-employed.
Businessman cash flow quadrant:- they are the ones who own a business.
Investor cash flow quadrant:- they are investors whose income comes from investments.

to which quadrants do you belong.

whichever quadrant you may be, if you want to make your money work for you need to make every effort to get into the investor quadrant.

Only then will you be able to achieve financial freedom.

A lot of us would love to be in the business quadrant, but few of us are not blessed with the skills or the abilities, or the resources to run a business.

so the best alternative would be to take a share of the profits of the company by way of dividends and capital appreciation. to gain a detailed perspective on the above concepts I would strongly recommend to the read the rich had, poor dad, cash flow quadrant by Robert T. Kiyosaki with Sharon L. Lechter ( C.P.A.)”

then the author talks about the best form of investment,

for that, you can read this in the book,

buy the book from the following image link

So this is all about the chapter 11 summary of the book ” stocks to riches ” by Parag Parikh on Financial literacy.

The Stock Market Bubble formation

February 11, 2022 by Laxman Sonale 2 Comments

Hello friends, I am Laxman Sonale, In Today’s article, we see the stock market bubble from chapter 10 of the book Stock to riches. In this chapter, the author explains the different types of thinking of participants in the markets. and how the government thinks, and how the system thinks, as well as how operator the benefits of any situation.

What are we learn from this Blog?

if you read this blog carefully then you realize how the system works, and how people play the game of the stock market bubble formation, and make the money. If you are a retail investor, then you definitely avoid this game, how to avoid detail, in this blog,

so let’s start

Previous chapter on Mutual Funds:- honest Review:–

Chapter 10:- The Stock Market Bubble formation

In this chapter, the author Parag Parikh talks about the financial bubble that happened in history. Their cause ad psychology of every participant. so let’s understand one by one the reason for their bubble formation and bubble bursts.

In starting the author says, ” The Stock Market are fascinating because they are so unpredictable furious activity is followed by long periods of lull. Many a fortune is made and lost. the Greed and Fear of participants make the stock market volatile. (The Stock Market Bubble)

The one who can understand this and in turn exploit it is easily the master. Stock markets are known for their intermittent bubble. to understand who and what causes them, we need to ascertain how the system works and what drives the participants. Systems Vagaries of the stock markets.”

then the author talks about how the system thinks about it.

System Thinking:-The Stock Market Bubble

In this, the author says, ” A system is that which maintains its existence and functions as a whole through the interaction of its various parts. The human body is a perfect example of a system. It consists of different parts and organs each acting separately yet all working together and each impacting the others.

Similarly, all around us, there are systems and systems within systems. System thinking is looking at the whole picture, the different parts, and the interconnection between the parts.

It thinking in circles, in loops rather than in straight lines. the parts of a system are all connected directly or indirectly. The action of one part affects the other and that other responds to the new influence.

The influence then comes back to the first part in modified ways, making a loop, not a straight line. This is known as the FeedBack loop.” (The Stock Market Bubble)

then the author gives the example of our hunger to understand the feedback loop

Hunger is a good example of this. When you feel hungry, you want to eat. so you eat as much as you need to satisfy your hunger. Once your hunger is satisfied you stop eating.

your hunger influenced your craving for food and in turn the amount of food. you ate influenced your hunger. it looks like one action but actually, it is a loop. it would be only one action if you knew exactly how much food to eat to feed your hunger and you ate that quantity of food.

When two parts are connected the influence can go both ways, like a telephone line; if you can dial a friend he can also dial you.

Feedback is the output of a system reentering as its input, or the return of information to influence the next step.

Feedback is fundamental to systems. there are two types of feedback loops.

Reinforcing Feedback:-

When changes in the whole system return to amplify the original change and this amplified change goes through the system producing more change in the same direction.

An example would be a snowball rolling down the hill. it collects snow as it rolls and becomes larger and larger until it eventually becomes a boulder.

Balancing FeedBack:-

When changes in the whole system return to oppose the original change and so dampen the effect. A balancing feedback loop is where the change in one of the systems results in a change in the rest of the system. that restrict, limit or oppose the initial change and keep the system stable, or else the reinforcing feedback would break the system. (The Stock Market Bubble)

Feedback is a circle. It takes time to travel round in a circle and so the effect can appear sometime after the cause. when there is a time delay between cause and effect and we assume there is no effect at all, we may be surprised when the effort suddenly happens.

What we do now will affect our lives in the future when the consequences come around again. We do not see the connection and we blame prevailing conditions but actually, the roots lie in our own past actions. We mold the future by our present actions.

Very often the most critical point of leverage in any system is the belief of the people because it is these beliefs that sustain the system.

The stock market is one such system and it is its beliefs and the behavior of its. Various participants from time to time shape their progress.”

then author explains each participants psychology, including governments, regulators, stock exchange, brokers, banks, companies

The Psychology of Stock Market Participants:-

At this point, you know each participant’s aim in the stock market, and how they think

in this author says, ” understanding the psychology of the participants is the key to knowing how they will behave when they are gripped by fear and greed. he who understands this psychology is able to manipulate the markets by using the different participants at different times.

Now let’s see what each one wants from the markets.

Governments:-

At this point when the world has become a global village and each country wants to attract foreign capital, governments need booming markets. (The Stock Market Bubble)

Stock markets are the barometer of an economy. they send positive signals to foreign investors when they are in a bull phase.

Booming stock markets create confidence and spur the governments to go ahead with their economic policies. No government likes depressed stock markets.

Regulator:-

Regulators are appointed by the government, the regulator also likes booming stock markets.

A rising market is evidence of good government it also results in additional revenue in the form of higher transaction of services charges due to the increase in turnover.

Stock Exchange:-

They facilitate stock transactions. during boom periods, incomes skyrocket, by way of transaction charges from brokers, listing fees, etc.

Brokers:-

in a bull market, the clientele increase and so do business opportunities. this results in higher incomes for the brokers.

Banks:-

Their business increases with soaring stock markets as opportunities open up in lending against stocks, margin trading, depository, and custodial business. etc.

The feel-good factor drives investors to banks for various financial services.

Companies:-

Rising markets lead to higher stock prices, the net worth of owners increases, and companies can map up more capital for expansions. Financially healthy companies are able to attract and retain good talent and keep their shareholders happy. (The Stock Market Bubble)

Mutual funds:-

Higher stock prices mean increased net asset value rising markets attract more investors which means more money under management fees. they are also able to come out with different kinds of funds to satisfy every requirement.

Media:-

The media plays a pivotal role in spreading information. an increase In investors means increased viewers/readers, which translates into increased advertisements revenue.

Investors:-

The lure of quick money draws investors into a bull market. Day traders become very active as they are rewarded with easy gains.

Operators:-

He is the smartest and shrewdest of all. he is aware that the bull run psychology creates the bull run. He knows the system, he understands the psychology of the participants and he has the ability to exploit that for his own benefit.

He is the king-maker who uses his knowledge to win over investors, brokers, and company management.

after this

the author explains how we make a bubble in the market.

Making the Bubble:-

in starting this point, the author gives the quote

: ” Whoever can supply them with illusion is easily their market.” – Guston Le Bun

so the author gives three points of making bubble.

1) Stock Price:-

At this point, the author says ” The fulcrum of the stock market is the stock price. the management of companies is the biggest beneficiary of a price increase and it is in its interest to keep stock prices high.

Anyone who promises to boost line prices easily becomes its master.

The operator understands the weakness very well, he tells the management that its company stock is undervalued and convinces it that he can take it higher. in most cases, he is a broker or an investment banker, which gives him the credibility of knowing the stock markets.” (The Stock Market Bubble)

then comes the role of the second point

2) The Deal:-

The management gives the operator some stocks at the current low price and a predetermined amount to rig the stock. the operator uses the money for his stock market operations while his profits come from a portion of the stock he is given at the beginning, which he sells when the price goes up.

A fixed amount of performance fees is also given to execute the deal. Over and above that the operator makes money by way of trading on his own account during the rigging process.

the third point is one circular trading

3) Circular trading:-

This author explains step-by-step circular trading.

Step-1:- The operator has his own band of brokers who specialize in such operations. the circular trading starts, Broker-1 sells shares to Broker-2 who in turn seel broker-3 who then sells to broker-4, and so on.

As the shares change hands the price increase. thus reported volume. when this data reaches investors they think that since the stock is moving something must be happening. (The Stock Market Bubble)

Circular trading picks up momentum and the stock price and volume increase, the referring loop is created. Even if there is pressure to sell the operator absorbs, it with the money given to him by the management.

If the conditions are bullish the operator and his band of brokers also, absorb the selling by taking their own positions.

This creates artificial scarcity and the reinforcing loop becomes stronger. see figure to understand the circular trading process.

Creating the Reinforcing Loop:-

At this stage, the manipulators can not exit. they are making the bubble, so they need to support the price, or else the reinforcing loop will break.

the Stock needs to get its momentum before it can stand on its own. So a fund manager of a mutual fund or an institutional investor is roped in to join the inner investment adds credibility to the stock.

Investors are lured by the entrance of these investors. This helps the rigging the gives credibility to the stock.

Step-2:-

Now the stock has got its feet. Regular Volume data and the rise in price attract investors. Saliency heuristic is at work. the rise in stock is seen as a positive turn in the fortunes of the company.

Slowly the stock becomes newsworthy. Stories about the company, its growth potential, restrictions, and so on appear in the stock market, journals availability heuristics at play.

All available information on the company is positive. the recall value for the stock gains prominence and more investors start buying. (The Stock Market Bubble)

The seed of Greed is sowed. With each price rise, demand for the stock increases, and other players such as retail investors join the game. fundamentals and valuations take a back seat.

The initial operator and his band of brokers at this stage do not do much except plant stories in the media, generate excitement about the stock by way of research reports, and convince another intermediate who in turn recommend the stock to their clients.

Essentially, their job is done. the stock is on autopilot. the bubble starts ballooning. at this stage, the manipulators are able to exit.

Stage-3:-

the net is spread, more stock market participants enter the fray. Banks and private financiers look for lending opportunities. the stock enters the list of stocks against which banks will give an overdraft facility.

this further enhances the credibility of the stock the stock builds huge volumes as genuine buying and selling take place.

Enter the media. Stock price movements are flashed on tv screens ad analysts recommend it at investment debates.

the stocks soar further on inflexibility as more and more investors enter the market, afraid that they will miss the bus. this herd mentality pushes the stock still further. Now with greed in the driving seat representative heuristic comes effect makes investors feel that the market is undervaluing their stock and they become more confident of their holding.

they become salesmen for the stock and recommend it to their own friends, and relatives. Each person becomes an expert in his own sphere of influence. the initial operator then exits and move to other stocks in the same industry where representative heuristic is at play. (The Stock Market Bubble)

the bubble is for real and the reinforcing loop is strong. all the participants in the market are happy, as each one is a winner. Between the cause and effect, there is an interval, the duration of which no one can predict. the balancing loop has to come up to play to correct the system is to be stable. nobody can predict when that will happen but happen it will.

The severity of the balancing loop is directly proportionate to the severity of the reinforcing loop.

then lastly the author explains how the bubble burst,

you can read this in this book, buying this book, from the following link

so this is all about the stock market bubble from book stock to riches.

Mutual Funds:- Honest Review

February 9, 2022 by Laxman Sonale 2 Comments

Hello friend, I am Laxman Sonale, In this article, we see Mutual Funds: an idea of when time has gone from chapter 9 of the book Stock to riches. In this Parag Parikh Explain the mutual fund industry and also the fund manager problem, as well as the destroyer environments. So let’s understand the most famous industry in finance.

Previous Chapter 8

Chapter 9: Mutual Funds: an Idea where time has Gone

In this starting author explain the real meaning of Investing, If you think investing or stock market is some magical place and those take the risk on that they win and become very rich in overnight. then you can ignore this article right now.

But if you invest in mutual funds without knowing about them, and their behavior/psychology, then this article helps you most to understand this industry.

you want to learn about investing and avoid the big mistakes of financial life/in mutual funds then you must read with understanding.

so hope you get the notification. so let’s start this chapter 9

At the start, the author says, ” Investing is a game of patience, and investors get rewarded if they invest for the long term. the longer one stays invested the greater are the rewards. Buy a value, sit on it, and left time to do the rest.

In today’s changing time’s investors shun the age-old wisdom of Long term investing and chase the illusion of short-term quick profits. Keynes is often quoted – ” In the long run we are all dead” – to justify the speculative urge of Short-term quick profit.

the strategy of short-term is to time the market rather than invest in good sustainable business. sometimes you go night and make a quick buck. (Mutual Funds:- Honest Review)

But the game of Timing can be very difficult and it is hardly advisable when it concerns one’s hard-earned money. Everything changes but there are certain principles that do not change. the power of principles is that they are universal timeless truths. if we live our life based on these we can quickly adapt and apply them anywhere world, we cling to practices, structures, and systems for some sense of predictability in our lives. we forgot the principles and we are headed for trouble.

Investment management is a profession but it is being run like a business. So the rules of sound investment take a back seat and the rules of business dominate.”

then the author explains the beginning of the Mutual funds

The Beginnings of Mutual funds:-

In this point, the author explains the history of mutual funds, and how this industry is born.

the author says, ” This industry was created to channel the savings of a vast number of small investors into the capital markets. it Is a vehicle to safeguard the interests of the small investors who are assumed to be incapable of taking investment decisions on their own.

The Mutual fund industry provides the basic infrastructure for professional investors, in the form of professional fund managers investment research, business analysts, stock market analysis, and system to cater to the huge pool of investors. the aim is to fulfill the long-term investment needs of retail investors.”

the rule of the Game of mutual funds

Long term Investment Strategy
Investor friendly: Exit Within 24 hours
Professional fund managers with strong market expertise.
Backed by strong Research Analyst.

You also know about these rules, when you start investing in mutual funds, in the form of SIP. so this is the main rule, let’s see the deep game, from the fund manager side, to understand this, the author explains The Paradox concept

The Paradox:-

the author says, ” Most mutual funds talk about long-term investment strategy. however, they are open-ended and the investor can exit whenever he wants.

The paradox is that on the one hand it talks about a long-term investment philosophy but on the other, it does not encourage the investor to be a long-term player. (Mutual Funds:- Honest Review)

this is because the normal practice in the mutual fund industry is to have open-ended funds and the principle of long-term investment takes a back seat, the game is that of timing the market and looking for short-term gains.

In Fact, it would be wrong to assume that investors do not want their money looked in for long periods. If that were true then people would not invest in RBI bonds, or past savings schemes for five to seven years, or in the public provident fund, for 15 years.”

then author blames this industry, for many reasons, let’s see one by one reason

the author says, ” The industry itself needs to be blamed for nurturing and nursing the culture of open-ended schemes. As the industry grew so did the competition leading to high marketing costs.

Money comes when the markets climb as the net asset values start going up. there is a scramble to get in and fund managers are pressured to invest in a rising market at inflated asset prices.

However, pull-out(taking out money from mutual funds) forces fund managers to sell the portfolio at depressed prices to meet the redemptions.

the basic principle of buying when prices are depressed and others are selling, and selling when prices are high and others are buying is not workable. fund managers are forced to act in a way that does not conform with the basic investment principle.

fund manager’s decisions are being controlled by the environment.”

then author talk about the Fund managers Behaviour, if you invest in a mutual fund, then you should this following paragraph carefully to understand fund manager behavior

Fund Manager’s Behaviour:-

the author says, ” Because of the pressure to perform in the short run, fund managers chase each other’s net asset values rather than follow sound investment strategies.

When the information, communication, and entertainment (ICE sector) moved up in 1999, fund managers chased those stocks, and prices rose steeply. (Mutual Funds:- Honest Review)

Most of them had the same ICE stocks among their Top holdings. at the time of the rise of the public sector understanding in the oil sector, most of them had ONGC, BPCL, and HPCL as their top holdings.

then when the fed passed, they competed to sell and depressed the prices. it is obvious that the herd mentality is what drives them to make decisions.

newspaper and financial journals report quarterly performance of funds. Influenced by this news, investors enter and exit funds forcing fund managers to change strategies midway. they are thus forced to keep up with market trends and this affects their performance.

Also, the practice of offering bonuses and rewards for turning in short-term profits rather than for following a sound investment strategy forces them to adopt short-term strategies. as a result, it is the investors who lose.

For if making short-term money was so simple in the market he would not be a fund manager. he would be busy making money for himself playing the market.

This is not to say that all fund managers are mediocre. the Indian capital market does have some very good talent and we need to create the right environment for such talent to flourish and at the same time reap benefits for the mutual fund holders.”

after this, the author explains the destructive environment for mutual funds.

Destructive Environment:-

In this point, the author talks about the mutual fund environment.

the author says, ” the mutual fund manager manages the money of investors whom he has not even seen. it is the sales team and third-party distributors who bring in the investors. In a situation where fiduciary responsibility is very important, not knowing the investor whose money he is managing can call his commitment into question.

Mutual fund managers have a file of cash to be invested in the stock markets. naturally, broker company managements and other operators chase them with quick money ideas. with so much attention being showered on them,

there is a danger that they could overestimate their abilities and performance. Sometimes the rewards for performance could also make them overconfident. (Mutual Funds:- Honest Review)

It is true that we can not blame the fund manager but the point is when there are so many good professionals in the field, they should not be forced to operate in less than conducive environments.

The business of a broker depends upon the number of resources he is able to mobilize for the fund. hence brokers may try to sell a fund to investors not because it is a good investment but in order to generate business from the purchase and sale of stocks.

The fund manager and the broker please each other for their own benefit and in the process, it is the investor who suffers.

the development of the mutual fund’s concept was perfect for its time. the idea was to pool together the resources of investors and invest them in the stock markets.

Professional fund managers backed by strong research would handle the investments. thus the investor was assured of the services of professionals. but times have changed.

The level of education has improved. information flow has increased. The Internet enables the exchange of information in real-time. Online trading enables real-time execution.

Chat sites ( like our blog) help investors discuss their views and seek opinions. the power of knowledge has shifted from the hands of a few to those of the masses.

We now have a web of smart professionals with new ideas knowledge and operations as compared to a handful who are working for the mutual fund industry.

in fact, the concept of mutual funds has become outdated. mutual funds are competing with millions of traders. and with so much volatility and pressure on performance, they have also become weekly traders, if not day traders.

our belief that mutual funds are good is getting another example of a mental heuristic.”

then the author talks about mutual funds as a profession or business.

Mutual funds: A profession or A Business

in this point author puts both scenarios of the profession and the business

author says, ” Money management is a profession. the professionals who make it are validated by their performance. unfortunately, the advent of mutual funds has turned it into a business where the goal is to increase the assets under management.

today, funds compete for the size of assets, chasing a benchmark of relative returns. the aim is to beat the top-performing fund. Even a poor two percent becomes a benchmark.

On the other hand, a professional like a portfolio manager will benchmark against absolute returns because in most cases has fees are linked to his performance.”

then lastly the author gives the solution of mutual funds.

Mutual funds solution:-

in this author explain the different types of mutual funds, and which one is best, let’s see

the author says, ‘ Open-ended mutual funds are the main cause of the volatility in the markets today. I believe that close-ended mutual funds(is a type of mutual fund that issues a fixed number of shares of their own fund) are the best vehicles for a long-term investor.

it allows the fund manager to be disciples, which in turn reaps substantial rewards for investors. no doubt the choice of such funds is limited. (Mutual Funds:- Honest Review)

In this case, the price of the fund could fluctuate according to the net asset value, but when the units change hands they go from one investor to another and there is no redemption on the fund.

the fund manager, therefore, is free to make long-term decisions because the environment does not control him. for the healthy growth of the mutual fund industry, more such close-ended funds need to be floated.

however, the irony is that close-ended mutual funds quote at a premium prior to listing and at a discount to the net asset value after listing. This discount may be viewed as an expensive monument erected to the inertia and short-sightedness of the shareholders.

The price movements of close-ended funds display the fickle behavior of investors as investor sentiment varies over time.

When noise traders are optimistic, the price of the net asset value narrows. when noise traders are pessimistic, the price of close-ended funds declines, and the discount to the net asset value widens.

Investors in close-ended mutual funds are subject to two types of risk: firstly, the fundamental risk of the net asset value going down, and secondly, the noise trader risk of widening the discount due to pessimism. The opportunity arises in the second scenario.

However, the investor would need the patience to benefit from such an opportunity. But isn’t investing a game of patience after all!

then the author talks about the future of open-ended mutual funds,

you can read this in the book, by ordering on the following image link.

Mental heuristics In Stock market

February 6, 2022 by Laxman Sonale 1 Comment

Hello friends, I am Laxman Sonale, In today’s article, we see chapter 8 from the book Stock to riches ( mental Heuristics). In this chapter the author, Parag Parikh explains how our mind is working in real life as well as in the stock market. Especially when money comes. So if you want to avoid losing money, then read this article, and understand it carefully.

let’s start

Previous Chapter 7

Mental Heuristics:-

At the start of this chapter, the author gives the two questions to test our mental heuristics, hey guys questions are so funny and logical, let’s see

Question 1:- Three birds are sitting on a tree, two decide to fly away. How many birds are there on the tree?

Question 2: Observe the following picture which line appears longer?

The bottom line appears longer but if you look at the diagram below you notice that both the lines are of the same length.

To support the above statement, the author gives the following diagram

the author gives the right answer to the first question

the author says, ” Although both the lines are the same why is It that the lower line appears longer? that’s because the brain takes a shortcut when processing information. I do not process all the information and this leads to biases. this process is known as mental heuristics.

If your answer to the first question- How many birds are there on the tree!- is one,

then you have fallen prey to mental heuristics. your brain does not the information properly. The answer should be three birds. Two had only decided to fly away.

They did not fly away had I told you that they flew away then you would be right.”

The first time I read it, I am also falling in bias

then the author gives the definite definition of mental heuristics and explains mental heuristics with examples

the author says, ” the dictionary definition of the word heuristics refers to the process by which people reach conclusions usually by trial and error.

This often leads them to develop thumb rules, But these are not always accurate. One of the greatest advances of behavioral psychology is the identification of the principle underlying these thumb rules and the errors associated with them.

in turn, these rules have themselves come to be called heuristics. In short, the following four statements define heuristics bias

People develop general principles as they find out things for themselves.
People rely on heuristics to draw inferences from available information.
people are susceptible to certain errors because the heuristics used are imperfect.
People actually commit errors in a particular situation.

Then the author gives examples of this

the author says, ” there is a newly opened megastore in the vicinity whose stock is listed on the stock market. you see a big queue outside it and you think it must be doing a roaring business.

You buy the stock hoping it will go up because the store is doing well. But there could be umpteen reasons for the queue the store definitely could be doing great business. But it is also possible that customers are queueing to return defective goods or perhaps the service is slow, or maybe all the other stores in the vicinity are closed on that day.

There are various reasons for the queue but our brain does not weigh all the probabilities and makes a decision on half-baked information.

Stock markets are interesting because Investors do this all the time.

then the author explains with reliance industries limited ( RIL) examples

the author says, ” when the company discovered a gas vein. the stock jumped as investors cashed in on this news. But let us analyze the situation without falling prey to mental heuristics.

the gas source was discovered but there were other factors to be considered the quality of the gas, the number of wells to be drilled, the time it would take, the plans to finance the project, etc.

Before the profits could be repaid yet analysts predicted the future profitability of RFL and on such hopes, investors bought the stock at rising prices.

This is how mental heuristics work when the brain does not process all the information and its implications. the tech boom was built on the same logic and we know the damage it has done.”

then author explains why we do this time by time,

the author says, ‘ Evolutionary forces shaped human cognition over centuries. that served our ancestors well, allowing for quick quality decisions.

Today, the complexities of our lives throw up multifarious data that sure minds may not assimilate very easily. The heuristics we help carry associated biases, which undermine the quality of our decisions. let’s take a look at some heuristics and their biases.”

then the author explains different heuristics

let’s see one by one

Availability heuristics:-Mental Heuristics

In this, the author says, ” One bias associated with availability is the ease of recall.

We are more likely to make judgments based on recent or easy-to-remember events rather than other similar but harder to recall instances. the flow of information around us is what happened in the India shining story of 2003-04.

All available information press, television, bureaucracy, business, and political circles, centered on the positive aspects of the Indian economy.

No negatives were permitted. shared by so much optimism the herd mentality comes into play and everyone not only believed the story, they advocated it.”

then the author explains, how these availability heuristics work in the stock market

the author says, ” this was reflected in the stock markets, the senses jumped from 2800 in April 2003 to over 6000 in April 2004. the NDA and its allies were sure they would win the electrons as the India shining story pointed a rosy picture of their governance. come May 2004 and the electron results announced that the NDA government had lost. How did this happen? the post-analysis revealed that the India shining story had been aggressively sold in the major cities; hence the exit polls in these cities placed the NDA’s chances very high. But 70 percent of the population lives in rural areas and for them, India was not shining. thus NDA was lost. (Mental Heuristics)

On may 17, 2004 the markets crashed by more than 800 points in just two days.

The reason:- All available information was negative. In bull markets, there is only positive news and in bear markets, it is only negative. that’s why markets go up or come down on reflexivity.”

then the author explains other heuristics, let’s see how they work in the stock market.

Representative Heuristics:-

In this, the author says, ‘ We assess the likelihood of an event by its similarity to other occurrences A predominant bias associated with this is an overreaction.

In the stock market, if the leaders report impressive performance, then all the stocks in that particular sector benefit.

the fortunes of the steel industry seemed to be changing and TaTa steel reported increased earnings profits. All the stocks in the sector including the junk and penny stocks attracted investors interest irrespective of whether they too would report increased earnings when the textile industry reported good profits, not only did all the stocks in that sector rise but companies in associated industries, like machinery manufacture, spinning mills, dyes, and chemicals also attracted attention. (Mental Heuristics)

Representative heuristics also affect investors’ actions. Investors try to replicate their portfolios by following the leaders. if they find that a leading find or broker or a respected personality has bought a particular stock they also buy the stock. in a way, this gives rise to the herd mentality.”

then the author explain saliency heuristic

Saliency Heuristic:-

In this, the author says, ” Individual over regret to un unusual event assuming it to be a permanent trend. Two airplanes crashed into the world trade center and the world stays flying the next day. Surely this type of incident has the next day. On the contrary, the next day was probably the safest time for flying.

In bull markets, analysts overreact to unusually good quarterly earnings assuming it would be repeated in the future and become bullish on the stock. In the bear market, they overreact to a bad quarterly estimate extrapolating it too for the future.

In 2004 second-quarter GDP growth estimates of 10 percent saw the markets going up on the assumption that the trend would continue. Actually, it needs to be sustainable to justify good times ahead, however, this is how saliency heuristic works with investors.”

then author gives overconfident examples, you can read this in the book, buy this book from the following link

then the author explain herd mentality with example in the stock market.

Herd Mentality:-Mental Heuristics

in the author says, ” Prakash bought a Maruti Western after carefully researching the decision. He was very happy with it and, enjoyed driving the car on his long haul trips to Lonavala. After a few months, a flood of strangers approached him and offered to buy the car at reduced prices.

The vehicle was in good condition and had done a few thousand miles. Worried that he had not made the right decision Prakash considered selling his Maruti at half his cost price. should he sell the car?

Before you answer, ask yourself what advice would you give him if he wanted to sell 1000 shares of Maruti, which he had bought for Rs. 400 and was now quoting at Rs. 300 due to depressed stock market conditions.

The history of the stock market shows that most investors buy stocks in companies or mutual funds for presumably sound reasons but exit their holdings the moment the market turns against them. (Mental Heuristics)

they sell when a bunch of complete strangers offers them less than what they had paid. Conversely, they will pay high prices for stocks or real estate, or paintings just because other people whom they don’t even know are willing to pay such prices. The dot-com boom was a result of such thinking.

In Stock market Parlance this is known as investing with the herd. We need to understand the manner in which the value of a stock or commodity is determined. To some extent what other people think matters a great deal.

Beauty may be in the eyes of the beholder but the value is often in the eyes of the buyer. If Prakash wanted to sell the Maruti then it was worth what the buyers would pay for it. But if he didn’t then he was the only one to decide the value of his car.”

then author explains how herd mentality work in the stock market

the author says, ” In the stock markets most often investors allow popular opinion and behavior to define value for them; sometimes for the good but often not their buying or selling decisions are made not on the basis of their own convictions, but on the value that strangers appropriate.

The Herd mentality affects business decisions to a great extent people try to replicate the leaders. In the end everyone behaves alike which leads to cutting prices for market shares. This is very common in the stock brokering business.

Technology has made it easy to install trading terminals across the country. So to survive in a competitive market, brokers have lowered their trading commissions to as little as 3 paise. the difference between one broker and another is the difference in their commissions, not in the value they offer their clients.

that how herd mentality works in business.”

after this, the author gives the size bias

Size Bias:-

In this author talk about two friends, that invest in the market with different time frame, let’s understand size bias.

Two friends, Gautam and Salman, are just out of college and have taken up jobs. from day one Gautam sets aside Rs. 300 every month, which earns him 10 percent per annum, after 10 years he stops as he has started a family.

Salman got married early and did not save anything for a long while. After 10 years, he began to set aside Rs. 300 every month earning him 10 percent per annum.

He continued doing this for the next 30 years until he retired at the age of 60. Salman’s investment was Rs. 1,08,000 while Gautam’s was only Rs. 36,000

When both retired who has more money? it would seem to be Salman as he has been saving for 30 years. in reality it was Gautam. (Mental Heuristics)

At 60, Gautam got Rs. 1,051,212 while Salman got Rs. 621,787. This is the power of compounding which investors normally forgot.

Salman could not make up for the 10 years that Gautam’s money compounded at an annual rate of 10 percent per annum.

We often tend to look at the big numbers and ignore the small ones.

In money matters, it is the small figures that make all the difference.”

After this author gives the wonderful advice to the trader, how their mind works, and how they recognize patterns.

this you can read in this book, buy the book from the following link.

So this is all about chapter 8 on mental heuristics from book stocks to riches by Parag Parikh.

Mental Accounting in Stock market

January 25, 2022 by Laxman Sonale 1 Comment

Hello friends, in today’s article, we see mental accounting in the stock market from chapter 7 of the book stocks to riches by Parag Parikh. In this, we understand, how we lose lots of money, by mental accounting error. This bias helps you to understand behavioral finance and get the idea of saving money and investing also.

so let’s start

Previous Chapter 6

Mental Accounting:- Stock to riches Chapter 7

In this, the author (Parag Parikh) gives us some instances ( examples ) to show how mental accounting works,

so starts

Example 1

Dilip has just taken an MBA in finance. He was intelligent and had a sixth sense when it came to picking stocks. He worked for a brokerage firm and was respected for his ability to read the markets.

After a couple of years, he married Sonia. At that point in time, he had around Rs. 2 lakhs in his bank account. the year was 1991 when the process of liberalization had begun and the stock market was just taking off.

Being adventurous, Dilip decided to use his savings to trade in stocks. It was a wise decision considering his track record as a stock picker and his past success with the brokering firm’s clients. In the first year, his capital increased to Rs. 8 lakhs.

In 1993, his capital rose to Rs. 14 lakhs. two years later, confident in his success, he quit his job to become a full-time trader.

Sonia did not agree with this decision but he told her this would give him more time to develop his skills by attending various seminars and keeping up with his reading which was so very important.

he continued to do well and in 1994, his capital increased to Rs. 30 lakhs. the couple went on a trip to London. Sonia was very happy as they had moved to their own one-bedroom apartment.

In 1995, his capital soared to over Rs. 60 lakhs and so did his confidence. Being conservative, Sonia preferred to play safe. She insisted that Dilip should put aside some money in different safe assets, which they could fall back on in times of need. She was against Dilip investing all their capital in the stock markets.

Dilip did not heed her advice. He thought the higher the investment the greater the profit. Their different approach to money created a rift between them.

Arguments followed and the relationship was strained. Dilip’s winning streak ended and he began to lose. But he thought that since he had a comfortable balance there was no need to worry.

he betted heavily in a market that was going down and by 1997 he had lost everything. His flat was mortgaged to a financer, and Sonia filed for Divorce.

She accused him of being a compulsive gambler who lacked the financial prudence to take care of his wife. She said he could not handle money and had lost Rs. 60 lakhs in just two years in spite of her warning to save for their future.

Dilip was shocked. he had only lost Rs. 2 lakhs and that also over a period of six years.

so while reading this example, we don’t know about mental accounting, so for this author to give the explanation, just wait for more two examples, then we get the three examples and their explanation.

Example 2

Sunil and John were good friends. they worked for the same company and were financially sound. they enjoyed the good life and decided that every Saturday they would dine at a five-star restaurant. Each would pay the bill every alternate week. The first Saturday they dined at the Taj and Sunil paid the bill of Rs. 3000 with his credit card. the next Saturday they dined at the Hilton and this time john paid the bill of Rs. 2800 in cash as he did not have a credit card. the following Saturday the bill was Rs. 4200 and Sunil paid with his credit card. Next when john was due to pay, once again he paid the bill of Rs. 3900 in cash. After a couple of more such Saturday bashes, John told Sunil that they should quit going to five-star restaurants as it was very expensive. Sunil disagreed. He felt they needed this recreation and that they could afford it. He insisted they carry on and John gave in much against his wishes. The next time Sunil had to pay the bill he forgot his credit card and paid cash. the following day he told john that he agreed with him about staying away from five-start hotels.

These examples also do not give direct thought to mental accounting,

let’s see example three

Example 3

Bomsi was a spectator at a cricket match. He had with him a bag in which he had carried his provisions for the day. During the game, he was seen talking loudly and frequently on his mobile phones of which he had three. Suddenly, in the midst of an interesting over, he was heard arguing with an ice cream vendor. the dispute was over price. Bomsi showed the vendor this bag and told him, ” I have bought everything from home, even water. The only thing I can’t bring is the ice cream because it melts. But I will not allow you to cheat me.”

Now Bomsi was a cricket aficionado. he cheered both teams enthusiastically. After the lunch break, a player completed a century and Bomsi was ecstatic. he called the ice cream vendor, grabbed his bag, and generously distributed ice creams all around.

Within the next three hours, he did this twice more. After the game ended he settled his bill with the vendor and even gave him a hefty tip. this man who had fought over the price of ice cream in the morning had distributed ice creams by the dozens to people he did not even know. When asked about what he had done, he replied, ” I love cricket and I love to gamble on the game. When I win I like to celebrate. all my bets paid off. It’s the bookies who are now paying for the ice creams, so let the people enjoy.”

after this example, the author gives the idea of mental accounting

the author says, ” Mental accounting is an idea developed and championed by Richard thaler It underlines one of the most common and costly mistakes people make when dealing with money. it’s the tendency to place different values on the same sum of money depending on how it has been acquired and the effort required to acquire it.

Traditional economic theory assumes that money is fungible, meaning that one type of monetary unit can replace another. this means that Rs. 100 in lottery winnings, Rs. 100 in salary and an Rs. 100 tax refunds should have the same meaning as they have the same purchasing power. but studies indicate this is not so with individuals. People mentally separate their money in different accounts, giving each account a different significance.”

The three examples mentioned earlier

demonstrate how mental accounting affects people’s behavior, the author explains

the author says, ” Going back to example one Dilip started with Rs. 2 lakh and now has nothing. to him, his loss is only Rs. 2 lakh because his gains in the stock markets were merely his winning from his original capital and so not his own money. He treated the two accounts separately Sonia, however, does not suffer from this bias.

In example 2, every time john paid the bill with hard cash he felt the pain of seeing money go out of his pocket. Sunil did not experience this pain when he used his credit card. But When he paid in cash he understand the pain of parting with the money. and his attitude changed. In our minds, we distinguish between cash accounting and credit card accounting. Actually, both are the same, but we view them differently because of our mental extravagant when we use a credit card.

In example 3, Bomsi was stingy with his own money. But when he won, he become very extravagant. to him, his winnings were not his own money but that of the bookies. Hence the celebration mentally, he accounted separately for his own money and for his winnings. Let’s see what you would do in the following two situations.”

After this, the author gives the two situations to understand the mental accounting regarding money.\

Situation A:- You have paid Rs. 500 for a movie ticket. When you reach the theatre. you find that you have lost the ticket! Would you buy a new ticket? or would you prefer to go back?

Thinks about this, and keep your answer in mind.

Situation B:- You go to the theatre to watch a movie. when you reach the ticket window you find that you have lost Rs. 500 out of the Rs. 2000 you were carrying. would you still buy the ticket?

now think about this also and give the answer to yourself.

and check is right or wrong from the author’s explanation.

the author says, ” Most people would say no to the first situation and yes to the second.

However, both entail a loss of Rs. 500 and the cost of Rs.1000 to watch the movie. So why take different decisions? Because most people segregate the loss of the ticket and the loss of cash into independent categories or accounts and therefore react contrarily to the two situations.

Mental accounting is directly correlated to our emotional state. to understand it better, let’s consider different types of mental accounts and the human behavior associated with them.”

So for better understanding, the author gives us real-life experience and how mental accounting is work.

Earned Income V/s gift Income:-Mental Accounting in Stock market

in this, the author says, When we receive our salary cheque we are careful how we spend it. For we that money is sacrosanct, the fruit of our hard work.

But if we got a gift of the same amount of money you would treat it very differently we may spend it lavishly.

Mentally, to us, this is free money, but our salary money is not what we earned it, hence mentally we put it into a different account.

So this type of mental accounting has so many times happened to me. I know you also face this type of mental situation.

let’s now talk about other experiences.

Quantity of the money in Question:-Mental Accounting in Stock market

In this, the author says, ” we create mental accounts according to the quantity of the money and treat them differently. A tax refund is a tax-deferred payment by the tax authorities.

But when we get a tax refund of say Rs. 1000 we are likely to spend that without giving it due thought. However, a tax refund of Rs. 2000 will set us thinking, whether to deposit it in a bank or buy mutual funds and stocks, we do this because Small amounts go into important decision accounts.”

so this type of mental thinking really happens in our life, so now we know that then from now we know this, then think before spend and remember this mental accounting.

let’s take another example in real life

Large Purchases V/s Small Purchases:-

In this, the author says, ” When you want to buy a fridge you make a lot of inquiries before making the purchase you check out models and prices and even brands when you have found the one you like you to do some hard bargaining and maybe get a discount of Rs. 500 on a fridge costing Rs. 20,000. That makes you happy, but do you do the same when shopping for groceries do you realize that if you put in a little effort and are able to save Rs. 10 a day, at the end of the year, it would add up to a savings of Rs. 35000? Compare this with the saving of Rs. 500 on an expense that may not recur for the next 10 years or so.

Many people are cost-conscious when making large financial decisions, but they relax their discipline when it comes to small purchases. but that’s where the difference matters.”

These things also happen with us.

let’s see about credit card and cash example

Cash V/s Credit Cards:-

In this, the author says, ” Today credit cards are a status symbol. Everyone wants one, and every book is aggressively marketing it. It is a big profit earner for the bank and a hole in the pocket for the user who is not aware of the harm it can cause remember the example of Sunil and John

Sunil realized the value of money only when he paid the bill in cash. Because we have different mental accounts, we treat cash and credit card transactions differently. People tend to shop more. If they use credit cards as against paying cash. Actually, both represent your own money. It’s just that credit cards make us extravagant since we don’t see the money change hands. Moreover, we pay interest on the credit offered it is for this reason that credit card companies do a flourishing business.”

lastly, the author gives the Sacred money examples

Sacred Montey:-

in this, the author says, ” Ramesh was a successful investor and had done reasonably well for himself. One day he inherited Rs. 10 lakhs from his uncle. The uncle had worked hard and saved his money all his life. He did not take any risks and looked after this money with care.

Ramesh treated this money as sacred as he had received it from someone. who had toiled all his life to earn it? He would not consider putting it into the stock market where he had done reasonably well. Instead, he put it into bank deposits. The money was marked ” Sacred ” in his mental account. Had his uncle been extravagant may be Remesh would have played the stock market with the money”

After this, the author gives the impact of mental Accounting on Investors.

Impact of mental accounting on Investors:-

In this, the author gives, four examples of the impact of mental accounting

the author says, ” Mental accounting affects not only our personal finances but is more pronounced in the world of Investments.

Why do investors hold on to losing investments? They may offer various reasons to justify their action but the fact remains that mentally they are unwilling to accept that they are making a loss. Mentally we tend to believe that we book a loss only when we sell. Intellectually we recognize the loss but we hope that it will vanish. this is a common mental accounting error.
Why do investors earn less interest and pay more? Ravi is highly educated, has a successful career in margin trading, and is a savvy investor, in spite of the high interests paid by him, his returns from the business seem quite handsome. Being conservative he prided himself on having comfortable bank deposits to take care of any unforeseen eventualities. He knew that the bank deposits offered a lower rate of return but he felt that was a price he would pay for the margin of safety, that banks offered. It is ironic that he pays high interest in his margin trading while his own money earns a much lower interest in bank deposits. How much better he would be if he utilized his own money for his own stock trade and avoided paying such high rates of interest. this is not a stray case; most people make such mistakes. The problem is that they have two mental accounts. – ” Safe Money” and ” Risk Money ” – For the same money ( it’s also called mental accounting)
Most people believe that a bonus share is a freebie given by the company to its shareholders. they even buy moe shares on such news but they are dead wrong. Companies give bonus shares to capitalize reserves and balance their finances. But investors don’t see it that way they consider it to be a windfall. This leads them, to become extravagant. Most investors suffer from this mental accounting error that’s why the stock markets rise on such announcements.
Day traders trade in and out of a stuck time and again, with very narrow spreads. they think that they are generating income profitably. but consider the transaction costs and the brokerage they pay on such volumes. What they are in actually is the business of enriching their brokers. and the tax authorities. It’s like buying groceries not heeding the cost.”

Then the author gives the plan of action and advice

let’s see advice first

the author says, ” Before discussing the plan of action it is important to understand that there are no set rules. the best advice is to refrain from using credit cards and to treat all monies equally.

We all have our individual faults and we have to decide what we need to do for ourselves. mental accounting also has its positive and negative aspects and it is up to each individual to know what is best for him for instance, If you are a big spender and unable to curtail your urges, mental accounting could be the most effective way to plan your fixed mortgage payments kids education fund and retirement savings.

In order to eliminate the harmful effects of mental accounting while preserving its benefits you need to audit your own mental accounting system.”

Then the author gives the plan of action for mental accounting, to avoid our loss

you can read this plan, in the book, buy the book, from the following link ( image)

so this is all about the mental accounting from chapter 7 of the book ” Stock to riches”

Decision Paralysis:-Stock to riches Chapter 6

January 21, 2022 by Laxman Sonale Leave a Comment

Hello friends, in today’s article we see the decision paralysis bias from the book stocks to riches chapter 6. In this, the author i.e. Parag Parikh gives wonderful examples that help us to understand this concept. so if you have some decision paralysis bias, then you have to read this article, and understand it, to avoid the decision paralysis bias.

Previous Chapter 5

Decision Paralysis and The endowment effect:-

for starting the author give wonderful examples, and then we try to understand the decision paralysis in detail, let’s start with examples,

Roopesh ( a businessman) has come to meet with Satish ( a portfolio manager).

Roopesh:- I am a businessman I have inherited from my father a portfolio of various stocks. He was an investor and he died five years ago. I’ve always wanted professional help on handling my portfolio as I know nothing about stocks and My own business keeps me busy.

Satish:- it would be a pleasure to construct a good portfolio for you. I have been in this profession for the last 20 years and have many high net worth individuals and corporates as my clients. could I have a list of your stocks?

Roopesh:- Here it is, Can we discuss it right now? I have already wasted five years doing nothing.

Satish:- At a glance, I can see that it is a very lopsided portfolio and drastic changes are required to balance the industry weightage. A number of stocks will have to be sold as they are not viable. Had you done something about the portfolio immediately after your father died you would not have been saddled with so many junk stocks? since we need to act quickly I will put my comments on this sheet. (Decision Paralysis)

Roopesh:- Oh, thank you so much for understanding the urgency of the situation and working on it the right way. I will get everything in order and meet with you the day after tomorrow.

Satish:- That’s may not be possible as I am extremely busy, how about next week?

Roopesh:- Satish, you know the urgency so please spare some time for me. I will adjust my schedule.

Satish:- Is 4. P.M. okay with you?

Roopesh:- It’s perfect. Thanks for squeezing me in I just need to get over this. I am so indebted to you for your time.

they meet at the scheduled time.

Roopesh:- I did some homework and I have a few queries.

Satish:- Please go ahead, I will clarify all your doubts.

The meeting goes on for an hour. Initially, Roopesh’s questions are the same but Satish is patient and clarifies all his doubts. the meeting ends with Roopesh scheduling another appointment after a couple of days.

Roopesh:- Thank you once again for your time You know how urgent this is for me so before I finalize I brought my wife along so that she too is clear about everything. Meet my wife Meena

Satish:- Nice meeting you. Now, what can I do for you? I hope your husband has explained everything to you. If you have any questions don’t hesitate to ask.

Meena:- I am just a housewife. I do not understand investments. My husband insisted that I come as he wanted to finalize some business with you. He told me that you are an expert in your field and he trusts you very much. I am happy that he has ultimately taken a decision after five years. (Decision Paralysis)

Roopesh:- Yes, I am glad I have met the right portfolio manager. now to complete the formalities and take action, shall we meet tomorrow? Please give me an appointment as this matter is my first priority.

Satish:- Okay. since we will require time to finalize, let’s make it 6 P.M. tomorrow.

Roopesh:- thank you very much. I will be there. I will bring my wife too in case you need her signature. goodbye.

The next morning, Roopesh calls Satish’s secretary and asks her to reschedule the meeting two weeks later, Roopesh walks in with a gentleman.

Roopesh:- Satish, meet my friend Atul. He is a leading chartered accountant. before finalizing. I thought he should meet with you and you can clarify his doubts. I hope you don’t mind.

Satish:- Yes, Atul please go ahead with your questions,

Atul:- I have heard a lot about you. I have nothing to ask a professional like you. I know Roopesh Is in safe hands. Roopesh, I know of Satish’s reputation and you can be assured that you have got the best professional working for you.

Roopesh:- thank you. Now Atul has given me the green signal I do not have any hesitation. I will call tomorrow and fix a time so that I can bring my wife and we can complete the formalities.

the next day Roopesh calls Satish’s secretary and asks for an appointment after three weeks as he has another urgent business appointment the secretary refuses to reschedule the appointment.

I know while reading these examples, we can’t get any logical sense, so read the following explanation to understand the logic of the above examples. (Decision Paralysis)

After these examples, the author explains about above examples.

the author says, ” Why did the secretary do that, especially after Satish had spent so many hours with a prospective client and the signing was a near certainty? What do you make of Roopesh’s behavior? Why was he post poring his decision? Suffers from decision paralysis. He can not make decisions and is resilient to change Satish had lost trust in him. He guessed that nothing would make him act. To buy time Roopesh went on a business trip, then bought his wife along, and after that his friend Atul. His wife and his friend were not even informed about the talk. He had had with Satish and neither was competent enough to ask Satish any worthwhile questions though Roopesh harped on the urgency of the matter and insisted that it was a top priority he just could not decide what to do. Perhaps he has been behaving this way earlier as well. He fears change, so he prefers maintaining the status quo.”

He understands that he needs to take action but he can not.

then the author explains decision paralysis or Status quo bias.

the author says, ” this phenomenon hampers us in many areas of life, from choosing an investment option to buying a house. Once you are familiar with the complicated forces at play you will understand why choice and change can be so intimidating.

A significant sequence of decision paralysis in financial decisions is that by deferring purchase you may miss the opportunities or run the risk of prices-rising. Imagine there is a very good house for sale. You like it because it suits all your requirements and the prices seem right. But you can not decide and opportunity to see a few more houses. With multiple choices a decision is difficult. As time passes another bidder enters the fray and you lose the opportunity. Because of decision paralysis, you lost the house.”

then the author explains, what factor needs to be making decisions.

Taking Decisions:-

In this author explain the different factors that need to take decisions

the author says, ” We have to understand that deciding not to make a decision is also a decision. when we make a decision we give ourselves a chance to have from the present comfort zone. Once we do that we have a 50-50 chance of going right or wrong. If we choose not to take a decision we miss this chance of going right.

Maintaining a status quo in times of continuous change is definitely unwise. Another way of looking at decision paralysis is that it is a natural human tendency to resist change.

So one is the reason that is why we can’t make the decisions.

Fear of going wrong
the possibility of losing
to avoid looking foolish
Unwillingness to take risks

then the author explain the above point

the author says,” All these reasons stem from our psychological and cognitive defects. the most acute of these is loss aversion and egocentric human nature. Along with that heuristics like regret avoidance and belief perseverance also play a significant role in our mental makeup”

then the author gives the illustration story to understand better way.

the author says, ” suppose, you inherit from your rich uncle Rs. 50 lakh and you want to invest it. You buy stocks, bonds, fixed deposits, etc. according to your preference and needs. It is simple you have the money and you allocate across assets. But if you were to inherit a portfolio of stocks amounting to Rs. 50 lakh, what would you do? you need to make multiple choices. You could sell the stocks in the portfolio and buy different stocks or some bonds etc. Or you could leave the portfolio as it is. Most people would choose to leave the portfolio as it is. they would choose to maintain the status quo. when there are multiple options. One is more likely to delay on action or take no action at all the greater the choice. The harder the decision.”

Then the author explains what is investing and decision paralysis relation.

Investing And Decision Paralysis:-

In this, the author gives examples to understand this relation between investing and decision paralysis in a better way.

let’s see examples

the author says, ” Decision paralysis plays an important role in Financial markets especially when you are dealing in the stock markets. the volatility of the stock markets also adds to distorted human behavior. Most people would do nothing or as well as we call it, maintain the status quo. Here are some examples of decision paralysis at work.

During the IT boom stocks reached new heights this went on for over a year. Those who invested in tech stocks become wealthly. a number of us, find managers and clients, thought that the markets were irrational and that the tech stocks were priced high. However, everybody wanted to ride the wave, confident that they would sell when the market softened. A fund manager of a leading mutual fund who also shared my opinion on the market. Valuations said he would sell when the tide turned. His fund had a weightage of 80 percent in the technology sector. When the market dropped it did not go down in one go. It was gradual before the steep fall come. Actually, the fund manager should have sold when the market began to weaken. He had been looking forward to such a situation, yet when the time come for him to do it he did not sell. He suffered decision paralysis and so did millions of other investors who made huge profits in the tech sector. I had consistently advised him to sell. He did not and suffered a loss when he liquidated.
We all remember the story of the unit trust of India ( UTI) the guardian to millions of Indian investors, corporate pensions widows working class, etc. Established in 1964 it was the only Indian mutual fund where Indians invested their savings. Operating in a socialistic environment the fund was open-ended but not net asset value ( NAV) based. It consistently distributed dividends and the governments supposedly guaranteed repayment. One could enter and exit at the price made available by UTI itself. Liberalization in 1991 and the entry of private and public sector mutual funds. Soon Challenged UTI’s supremacy. Despite operating in a competitive environment it continued to follow its earlier policies. In 1995 the stock markets boomed. that was the time to make it open-ended and let investors enter and get at the current NAV. times were changing and UTI’s position was threatened. The writing was on the wall but no action was taken. The Deepak Parikh committee was appointed to advise restructuring of UTI but nothing was done. Until one day the inevitable happened. this not only shattered the investors of UTI but also shook. the stock markets and it took over a couple of years for the markets to recover.
Another example of decision paralysis is when investors buy top-performing funds and do not reshuffle. their portfolios. they are happy since their funds are doing well. but when there is a choice of funds it is important to choose the right one, which may not necessarily be the one that has performed well. On the contrary, the chances of it sustaining its performance are much lower. By definition, a mutual fund captures the mutuality of the market so in the bull phase you should reshuffle. don’t let decision paralysis hamper your investment decisions.
Greed and Fear are a part of the market flow excess characterize the bull phase where every stock is sellable. During such a phase all types of companies enter the capital market to capitalize on the bull run. Money becomes easily available. Investors get trapped by such stocks when the bull run ends they swear they will get out of such stocks as soon as they can. For years they prefer to maintain the status quo as they get greedy, hoping to make more money on such junk stocks.

then on these examples, the author gives a short note.

the author says, ” I have come across various examples of investors who are unable to decide and prefer to maintain the status quo. why do people behave this way? Is the prospect of change so frightening? yes, it is and the concept of the endowment effect explains it all.

then the author explains the endowment effect

Endowment Effect:-

to understand this effect, the author gives the two situations, and their explanation.

The author says, ” What would you do in the following situations?

1 ) You have been gifted a souvenir jug worth Rs. 100 ( in the marketplace). Someone offered to buy it from you. What is the very least you would expect to be paid for the jug?

A) Rs. 100

B) Rs. 80

C) Rs. 70

D) Rs. 50

second situation

2) Your neighbor has received a souvenir jug worth Rs. 100 ( in the marketplace) as a gift. he offers you the jug for sale. What are the most you are willing to pay for the jug?

A) Rs. 100

B) Rs. 80

C) Rs. 70

D) Rs. 50

It is obvious when someone offers to buy the jug from you, you would like to be paid Rs. 100. but when the same jug is offered to you, you would like to pay only Rs. 50 why is there such a big difference in the price offered and the price tendered when the person is the same and the jug is the name?

Because we perceive that whatever belongs to us is more valuable than that belongs to others. When something comes into our possession its value increases. In a way, this explains why people prefer the status quo to change by foregoing change in favor of the familiar they express happiness with the current situation. True, a decision to do or not to do something would be influenced by a host of other factors such as doubt, fear, or confusion.

Nonetheless, keeping things as they are is a vote of confidence for the current circumstances, irrespective of whether they are good or bad. a preference for holding on to what you have is a lot stronger than most people think.

because people place an inordinately high value on what they have, a decision to change becomes difficult. Of course, people do manage to overcome this tendency, for if they didn’t they would not sell their homes as trade their used cars, or divorce their spouses. but to the extent that the endowment effect makes it difficult, to properly value what is and isn’t yours, you may fail to pursue options that are in your best interest. In fact, the endowment effect is just another manifestation of loss aversion. people, place too much emphasis on instant gratification and too little value on Opportunity Costs.”

then the author talks about the impact of the endowment effect.

Impact of Endowment Effect:-

To understand this effect impact author gives us real-life examples, in that examples how the endowment effect is used. let’s see step by step

the author says, ” The endowment effect is very relevant to invest. Stock market participants, Analysts, Fund Managers, and companies all become victims of the endowment at one time or other. here are a few examples of the endowment effect as it plays out in real life.

Overvaluing One’s Holdings:-

Ganesh:- “ What is the price of Tata Steel?”

Broker:- ” It is Rs. 298/299 ”

Ganesh:- ” Give me a call when it reaches Rs. 300, I need to sell.”

the price reaches Rs. 301.

Broker:- ” The price is Rs. 301/302. Should I sell? It is one rupee above your limit of Rs. 300.”

Ganesh:- ” No. The market seems to be going up I will wait for a price of Rs. 305, give me a call then.”

the prices go up to Rs. 306 and the broker calls.

Broker:- “ The price is Rs. 306. What should I do.”

Ganesh:-“Wait till it touches Rs. 315. then don’t even ask me, just sell. I am sure it will go up. This is a great company and such a low price is ridiculous.”

the price falls to Rs. 301.

Broker:- “ The markets are down and the stock is back to Rs. 301.”

Ganesh:- ” The market may be down but the stock can not go down. I know we will get the price Tomorrow. when the markets are up. don’t worry we will sell tomorrow at Rs. 315. I just can’t believe that the market is selling a good stock so cheap.

After these examples author explain why Ganesh does that

the author says, ” Every time the stock went up Ganesh would increase his limit. Was he playing games? No. he is a serious investor. He strongly believes that Tata Steel is a great company. He is proud of his holding and he firmly believes that the market is undervaluing his stock.”

Other Examples

The Trial and Money-back Guarantee scheme:-

Raju:- ” Mom, see what I’ve got, the latest stereo system. It will fit perfectly in our drawing-room. Wait till I play it. you will love the sound.”

Mom:-” Raju, where did you get the money for such an expensive stereo.”

Raju:- ” it’s on a 15- day trial basis. the shop round. the corner allows you to use the goods before you buy. Since college is closed for two weeks. I thought I’d listen to some music at home.”

Mom:- ” Are you sure they will take it back without any fuss?”

Raju:- “ Of course mom, don’t worry. here is the card. It says that they will take it back no questions asked, it returned within the 15-day trial period.”

Mom:- ” that’s great, handle it carefully. They may not take it back if it is misused.”

Raju:- “ Don’t worry I will be careful.”

After 14 days,

Mom:- ” Raju, don’t forget the trial period ends tomorrow. we have to return it, though we will miss it.”

Raju:- ” Mom, can we keep it and make the payment A good system makes a difference. Moreover, it fits in with our decor like it was specially made for us.”

Mom:- ” Yes, you are right. let’s keep the stereo we will make the payment.”

so you get the idea of the endowment effect. (Decision Paralysis)

then the author gives us an explanation.

the author says,” Notice how taking a product on trial got Raju and his mother to buy it. the shop owner understands the endowment effect very well. he knows that once the stereo becomes a part of their endowment it will be very difficult for them to part with it. they did not find out whether the stereo is competitively priced, whether there are better models in the market, or whether some company has introduced a better model.

Because it had become a part of their endowment it become very precious to them.

Businesses understand the endowment effect too well that’s why they are willing to give their product on trial with a money-back guarantee on purchases. they know that once customers own the product, even if it is for a few days, its perceived value increases, and they may not want to return it.”

So for avoidance the investing mistakes by cause of decision paralysis and endowment effect.

the author gives us the perfect plan of action to avoid this.

so, if you want to read that plan, you can read that plan in this book, by ordering this book from the following image link

to Solve the following problems

You have a hard time choosing investment options.
you react adversely when your decisions turn out poorly.
you buy products on trial but never return them.
You delay making investment and spending decisions.
you hold on to stocks you own.
You go on a company visit and buy stocks
you do not have a retirement plan in place.

So, this is all about decision paralysis and the endowment effect.

I highly recommend buying these books, from the above link,

if you buy these books, you will avoid losing millions of money on useless things.

so then buy these books, and improve your investor behavior mindset.

Loss Aversion from Stock to riches Chapter 5

January 16, 2022 by Laxman Sonale Leave a Comment

Hello friends, in today’s article we see chapter 5 from book stocks to riches by Parag Parikh. This chapter is all about two concepts i.e. Loss Aversion and Sunk Cost fallacy. lose aversion bias is the most famous bias that people use in their life and take wrong decisions. so let’s understand this concept and use it in our Investor journey.

Previous Chapter 4

Loss Aversion & Sunk Cost Fallacy:-

In this chapter, we learn about the most famous concept of psychology. before starting author give Warren Buffett ( great investor) and Benjamin Graham ( father of value investing) quotes.

” I will tell you how to become rich. close the doors. Be fearful when others are greedy, Be greedy when others are fearful.” – Warren Buffett lecturing to a group of students at Columbia University.

” Most of the time, common stocks are subject to irrational and excessive price fluctuations in both directions as a consequence of the ingrained tendency of most people to speculate or gamble to give way to hope fear, and greed.” – Benjamin Graham ( father of value investing)

the author explains how this emotion actually works in the stocks market i.e. fear and greed

the author says, ” We have all heard that investors greed when the stock markets are in a bull chase and their fear when the markets are falling. It is important; therefore to understand how these emotions of greed and fear impact our thinking and make us act in ways that are contrary to our financial markets? How do we make decisions when faced with risk? How do fear of losing and greed for gains impact our decision-making?

then the author explains, loss aversion and sunk cost fallacy

the author says, ” As far as our feeling toward our losses is concerned, we suffer from two behavioral Anomalies: Loss Aversion: that is our fear of losing, Sunk cost fallacy:- that is our inability to forget money already spent.

As far as our feelings towards gains are concerned, we suffer from status Quo bias that is our Inability to make decisions, and the Endowment Effect that is the tendency to fall in love with what we own and this resists change.”

after this, the author gives examples of loss aversion. you should read in the book, for that buy this book, from the following link

To understand more about the loss aversion concept, the author gives us two scenarios, this is a wonderful scenario, I bet if you will read it the first time, then you definitely give the wrong answer. (Stocks to Riches Chapter 5 on Loss Aversion )

the author says, ” let’s take a look at the following two scenarios.

Scenario 1:- you are given Rs. 1000 and two options

A) Guaranteed win of Rs. 500

B) Flip of a coin. If it’s heads you get Rs. 1000 and if it is tails you get nothing.

Which option will you choose? Now let’s go to Scenario 2

Scenario 2:- You are given Rs. 2000 and two options

A) Guaranteed to lose of Rs. 500

B) flip of a coin. If it’s tails you lose Rs. 1000 and if it is heads you lose nothing.

Which option do you choose?”

After this, the author gives the right opinion before that read this scenario again and keeping in mind your option.

then the author says,” Research Suggest it’s more than likely you chose option A in Scenario 1 because there was a guaranteed win of Rs. 500.

you acted conservatively and took the opportunity to lack in sure profits But in scenario 2, you would most likely choose option B because you did not want to be confronted with a guaranteed loss of Rs. 500.

Hence you were willing to take more risks if it meant avoiding losses. It is this bias that makes gamblers so popular with the casinos. (Stocks to Riches Chapter 5 on Loss Aversion )

Why is it that when confronted with a sure profit we become conservative and when confronted with a loss we tend to take more risks? it’s because the pain of a loss is three times more than the pleasure of an equal amount of gain.

Over time pain becomes terrifying and pleasure becomes boring. consider this, you get an electric shock while using your T.V. that will scare you and you will avoid going near the TV till the fault is set right.

Now contrast this with the pleasure you get when you buy a car for the first time. After a while, you get bored with it and you long for a better and bigger car. It never stops your desires keep upgrading because pleasure over time becomes boring.

We tend to see losses and profits in isolation and that is the reason we are more prone to suffer from loss aversion. Hence, we should not view different stocks or different classes of assets individually but as part of the portfolio as a whole.:

then the author gives examples of equity

the author says, ” suppose, there is a decline of 10 percent in equities and a rise of 8 percent in bonds, we should look at the overall effect which is only 2 percent. or take the case of a portfolio with 10 stocks, each valued at rupees one lakh. If two stocks depreciate by 50 percent, the overall effect on the portfolio is only 10 percent but if we were to look at the stocks in isolation we should see it as two stocks losing 50 percent in value that’s a big shock, and we could make decisions that we repent later.”

then the author gives the answer of before given scenario

the author says,” In the scenarios mentioned earlier if we looked a the final financial position after exercising the options, the automatic choice would be option A in both cases as it would leave us with Rs. 1500.”

then the author gives the impact of loss aversion

Impact of Loss Aversion:-

Investors tend to prefer fixed income investments to stocks
Investors tend to take their profits very early
Investors take more risks when threatened with a loss
Investors tend to hold on to losers and sell winners
Tax Aversion.

1) Investors tend to prefer Fixed income investments to stocks:-

In this, the author says, ” witness the period of after the bursting of the dotcom bubble till the beginning of 2003, everyone was so afraid of losing that they preferred to stay invested in fixed income securities they shunned equities although that was the best time to invest because of attraction valuations and good dividends yields. the pain of investors losing fortunes in technology stocks was so vivid and true and true that investors were not willing to risk anything in the stocks markets. the emotion of fear was so strong it created loss aversion. Actually, the right time to invest is when others are scared.” (Stocks to Riches Chapter 5 on Loss Aversion )

2) Investors tend to take their profits very early:-

In this, the author says, ” To be successful in the stock markets it is important to ride the winners and discard the losers. However, loss aversion makes us ultra-conservative so we book profits very early. we all suffer from loss aversion and that is the reason we find that winners get a small number of profits and losers pile up huge losses. winning streaks tend to be short-lived.”

3) Investors take more risks when threatened with a loss:-

In this, the author says, ” They tend to lose their balance. when confronted with a loss and become more daring and venturesome. this is not due to courage but because of madness caused by the pain of a loss.

One of our clients bought 10 low-valued stocks all quoting below par. when I questioned his wisdom in putting his hard-earned money in such stocks he replied that if just a couple of them turned out to be multi-baggers he would make good money he believed so strongly in his strategy that he held on to over a hundred such junk stocks in the hope that one day he would make it big. since he was losing he kept taking bigger risks and increased his exposure.”

4) Investor Tend to hold on to losers and Sell winners:-

In this, the author says, ” A portfolio of stocks with a few winners at the top followed by a long list of losers is not uncommon. as discussed earlier, it is because we go for sure gains and take more risks when threatened with a loss. so if you have one such portfolio you need to know that your decision-making is being controlled by loss aversion. Instead of riding the winners, you are riding the losers.” (Stocks to Riches Chapter 5 on Loss Aversion )

5) Tax Aversion:-

in this, the author says, ” People are always wary of paying taxes. this is also one sort of loss aversion tax is an outflow and it is considered to be a loss but in reality, we pay tax on our income we need a change of mindset. always count your income net of taxes this will enable you to avoid tax aversion arising out of loss aversion.”

then author explains about the Investors, after giving the impact of loss aversion

the author says, ” the idea that investors are not risk-averse but loss averse is one of the main tenets of behavioral finance. while the distinction might seem trivial; studies have shown that investors will increase their risk, defined in terms of uncertainty, to avoid the smallest probability of losses. it is not so much that people hate uncertainty, but rather that they hate losing.?”

Friends, this concept looks easy, and you think that that’s only, I know already, but from my experience when we include our hard-earned money, then we go in this loss aversion concept, and most of the time we lose.

So I recommend you to be cool and don’t say, it easy, this is not easy, it’s simple, and simple things is not easy

so let’s come to our topic

then author explains our Sunk Cost fallacy concept

Sunk Cost fallacy:-

To understand this concept, the author gives some examples, that we use in daily life, and how sunk cost fallacy occurs in our daily life.

examples 1)

Investor:- I have invested in Sterilite Optic, it is a great stock. I have read about the telecom boom and I am sure this is right.

Broker:- the telecom crazy has ended, there is overcapacity and the story is over the stock is going down as the industry fundamentals have changed.

Investor:- so what, I will buy more and bring down my cost of purchase. I know it was a great stock please buy 2000 Sterilite Optic.

Examples 2)

Housewife:- I thought investing was fun so I enrolled in these classes. I think I have made a mistake as I feel I am not cut out for this. but I will complete the course as I have already paid the fees and they don’t have a refund policy. (Stocks to Riches Chapter 5 on Loss Aversion )

Example 3)

Student:- I am not interested in commerce. I took it because I wanted to be with my friends. I know I have made a big mistake. But since I have already completed three years I would rather complete the rest and take the degree.

Example 4)

Businessman:- In the last two years, I have spent so much money on car repairs, I would have been better off buying a new one.

Examples 5)

Teenager:- Oh, what a boring book, I should not have wasted my money on it. With great difficulty I read the first 30 pages, I still have 400 more pages but I hope to complete that by the end of this week.

Example 6)

Day Trader:- it’s really tough to make money in such volatile markets. I should not have got this terminal at home. It’s a fixed expense every month, I have to trade every day so that I can at least recover my fixed costs.

After these awesome examples the author gives the two scenarios, just like the loss aversion concept scenario, and after that author gives the above examples, which is right and what should we have to do right for them.

the author says, ” why do people do what they do not like? Is it not simpler to choose not to do it? Now, what would you do in the following two scenarios?

Scenario A:- You have complimentary tickets for a Filmfare awards night. On the evening of the program, there is a severe rainstorm, and traffic is disrupted due to floods. You have to travel from Colaba to Andheri.

Would you go? Yes or No

Scenario B:- You have bought a ticket for a Filmfare awards night for Rs. 1500 on the evening of the program there is a severe rainstorm and traffic is disrupted due to floods. You have to travel from Colaba to Andheri.

Would you go? Yes or No

Choose your answer wisely,

then the author explains, what is the sunk cost fallacy concept and behind this scenario how these works.

and also explain the psychology behind this scenario

the authors say, ” Most people would go for the show if they had paid for the tickets and would avoid it if they had received the same as complimentary. actually, this distinction makes no sense as the money for the ticket is already spent. you will not get it back whether you go to the event or not. What we must really look at is the additional risk we are taking by braving the Strom and the additional costs we may incur if the car is damaged or we fall sick. the danger posed by the rainstorm is the same, whether the tickets are free or paid for.” (Stocks to Riches Chapter 5 on Loss Aversion )

This particular type of loss aversion to which we all are prone is what Richard thaler described as the Sunk Cost Fallacy.

You increase your commitment to justify your past actions because your ego is tied to be commitment.

then the author explains Sunk Cost Fallacy, for the previous six Examples

the author says, ” Let’s go back to the statements given earlier

the investor make a decision and does not want to admit that his decision has gone wrong. so to justify it he buys more stock and takes solace in that he is bringing down his cost of purchase.
The Housewife goes through the ordeal because she is already enrolled. She does not consider the extra time, energy, and money, by way of transportation, she will spend to fulfill the original wrong choice.
the student takes his graduation because he has already completed three years, would he really learn much when he is not interested in the subject?
The businessman should have recognized that there is something like the economic life of a car rather, he chose to continue spending on repair as every time a new expense come up he thought of the previous repair cost and thus went on and on.
A teenager has already spent on the book, so he will finish it however boring and time-consuming it is.
the day trader operates a business he knows will fail, but since he has already incurred fixed expenses he will keep going.

then the author says, ” each of them had a choice, to do or not to do. However, they considered doing what they don’t like because they wanted to justify their previous actions, also, they did not want to appear wasteful and incompetent in their financial decisions.

But Sunk cost Fallacy can also help us in a positive way. for example, a person joins a gym vowing to work out regularly. Instead of paying daily charges if he were to take a yearly membership, the sunk cost fallacy would help him to be regular, as he has already expended the year’s fees. This serves as a motivation to keep going.”

then the author explains, what impact of sunk cost fallacy

Impact of Sunk Cost Fallacy:-

1) Averaging Cost of Purchase

2) Spending on Repairs

3) Government Spending on Unviable project

let’s understand one by one

1) Averaging Cost of Purchase:-

In this, the author says, ” generally, when investors go wrong in their purchase of stock they buy more at every fall. they believe that this will bring down the cost of their purchase. there is nothing wrong with that, provided they are confident that the stock has great value. But if they buy only to justify past actions, then they are prone to sunk cost fallacy.”

2) Spending on Repair:-

In this, the author says, ” Two years ago you pointed your old car. last year you replaced the tires and changed the suspension. this year the mechanic informs you that the engine needs an overhaul. every year you justify your spending on repairs because of earlier expenditures when actually you need to discard the car as it has reached the end of economic life. Maybe it is wiser to buy a new car. spending on repairs is a common sunk cost fallacy with most of us.”

3) Government Spending On Unviable Project:-

In this, the author says, ” Bureaucratic procedures have delayed a project and it has now become unviable but a lot of steel and cement have already reached the site and the plants are ready. The initial fees of the engineer have been paid. Since so much money has already been spent the project is completed even though it is unviable. this is how sunk cost fallacy works with the government”

then the author gives examples of how the sunk cost fallacy occurs in day-to-day life.

the author says, ” the influence of sunk cost fallacy is evident in our day to day lives. How many times have we not sat through a boring movie just because we had bought the tickets? Here are some examples of the impact of sunk cost fallacy

At a buffet (the system used in an event to provide foods) there are a variety of dishes as the restaurant has to satisfy the palates of different types of people. Instead of exercising our choice, we tend to overreact only because we have paid for it. that is sunk cost fallacy working on us. the next time you go to a buffet, remember your health is more important than indulgence.”

It is not enough to understand the two behavioral anomalies of loss aversion and sunk cost fallacy. We have to recognize our own anomalies so we can improve ourselves and become better investors. (Stocks to Riches Chapter 5 on Loss Aversion )

So this is all about Loss aversion and Sunk Cost Fallacy concept.

In this chapter, the author gives the suggestion to become a better investor, I think you should read this in the book for you can buy the book from the following link

lastly, the author gives some questions to understand you are the victim of loss aversion and sunk cost fallacy

answer the questions

Do you prefer fixed income securities overstocks
Are you tempted to move out of the markets when the prices fall?
Does your portfolio consist of a few winners followed by a long list of losers?
Do you sell your winners fast and hold on to losers
do you make important spending decisions based on your past spending?

then the author gives the right answer

the author says, ” if your answer is yes, then you are a victim of loss aversion and sunk cost fallacy.

then the author gives suggests avoiding being a victim or loss aversion and sunk cost fallacy.

buy this book, from the above image link, and improve your portfolio performance.

Stocks to Riches Chapter 4:- Introduction to Behavioural Finance

January 14, 2022 by Laxman Sonale 1 Comment

In today’s blog, we see the introduction to behavioral finance from chapter 4 of the book stocks to riches by Parag Parikh. This is a wonderful chapter you should understand how our feeling is work in the stock market and how can we have to get precautions.

so let’s start

Previous chapter

Introduction to Behavioural Finance:-Stocks to Riches Chapter 4

In this chapter 4, the author explains behavioral finance with wonderful examples

let’s start with examples of peoples behavior

“With such positive news from the company why is the stock going down”
“I am a qualified chartered accountant. I went through the finances of the company and I feel that at the current price, the stocks are too expensive. I would not buy it nor recommend the same to anybody. But I am surprised that in the last two weeks the stocks are up 15 percent.”
“My friend works with this company. they told me that it was doing exceedingly well and that they have an export order worth crore in hand so I bought the stock. It’s six months and I have been waiting but the stock is going down.”
” the company has announced a 1:1 bonus, it’s good news so I bought the stock but the stock went down instead of going up like I thought it would.”
” I read the mornings newspaper and was impressed by the finance minister’s speech and his intention to give sops to the economy. the markets greeted the news positively and went up so I bought stocks the next day the markets were down for no reason and I lost on my investment.”
” I heard the expert’s comments on T.V. on the current budget presented by the finance minister. they were not very happy with it. I sold my stocks only to find that within a week the markets were up 10 percent. I don’t know why I sold my stocks which I had been holding for the last four years.”
” I can not understand the markets. I would rather stay away.”

after his behavioral statement, then the author tells, how this statement happens

the author says, ” Aren’t all these statements familiar you have heard them on perhaps made then yourself. In an ever-changing and uncertain world, we are trying to find some predictions where none exists. The easiest thing to do is to avoid such irrational markets. But then you would be missing out on one of the most favorable modes of investment. (Stocks to Riches Chapter 4)

My sincere advice would be to catch the bull by the horns. confront the problem rather than run away from it. Try to understand why it is happening to you.”

then the author gives their own experience, in dot com bubble time.

the author says, ” during the IT bubble. Too found myself bewildered and confused. The valuations of the dot-com businesses and IT stocks seemed highly inflated. Pundits in the market and the media were pontificating on the new economy and giving convoluted justifications for what was approved to be sheer insanity. I wondered, was the entire world mad and I the only left the same, or was I insane and the world perfectly rational?

I had a client who had invested around 70 lakhs in different IT stocks in 1998 on his friend’s recommendations in 1999, his portfolio value was around Rs. 5 crores when he asked for my advice I told him, to sell as I thought that the PE multiples were very high and the valuations seemed for too stretched.

He did not do so and six months later when we met he informed me that the portfolio value was around Rs. 6 crores. Once again he asked me what he should do I was a bit embarrassed by the question, as I knew that he was, not asking for advice. but telling me indirectly that I was not in sync with the markets. I still insisted that he sell but he did not sometimes later the portfolio value went up to Rs. 8 crores.”

then the author explains why they 3 times give the wrong advice and his friend portfolio value is growing continuously.

the author says, ” this was the frustration I had to go through, of being in the investment business and not able to advise clients correctly. there were times I had sleepless nights fearing that the world was going too fast for me to understand. I doubted my abilities, my competencies, and my knowledge. (Stocks to Riches Chapter 4)

The inability to understand the madness added to the frustration. In fact, I lost quite a few clients as they thought that I was too conservative and not in tune with the new economy.”

then the author tries to find out the answer, for the above going wrong, why this happens

the author says, ” find an answer to this question I did some serious soul searching. my quest led to a fledging little know field called behavioral finance. ”

then the author explains, how emotions change and he is right with his decision, the only people, driven by their emotions. to understand this, the author gives good examples of true stories

the author says, ” this is a true story of a friend who ran a coaching class with one of his colleagues they started off well and within a couple of months they were full to capacity after six months, few students complained to my friend about his colleague’s rude behavior.

The allegation was that he was very short-tempered and arrogant. they wanted him removed or else they would discontinue the classes. My friend was worried. this colleague was his partner and he could not be removed. Moreover, he was a brilliant professional and an able tutor.

After a couple of weeks, the colleague fell ill and was absent for some time. the students were very happy. they thought that they had been successful in removing him.

one day my friend learned that the colleague had a brain tumor and needed an operation. this news shocked my friends, as now his partner would be out of action for quite some time. He informed the students of this calamity. the students were stunned and this shock changed their attitude. Hatred and resentment gave way to empathy and love. they visited him at the hospital and took him flowers. they repented their stand and prayed for his early recovery so that he could come back to teach.”

then the author told, what is the purpose behind this story.

the author says, ” purpose of this story is to understand that is humans we are emotional beings and our behavior and decisions are guided by our emotions. Frequently emotions prompt us to make decisions that may not be in our rational financial interest. Indeed decisions that enrich us emotionally may impoverish us financially.” (Stocks to Riches Chapter 4)

Behavioral finance is the study of how emotions and cognitive errors can cause disasters in our financial affairs.

then the author explains, Classical economic theory vs behavioral economic theory.

Classical Economic theory V/S Behavioural Economic theory:-

the author says, ” Classical theory talks about the efficiency of the markets and people making rational decisions to maximize their profits. It assumes that the markets are efficient and no one can take advantage of its movements. It also assumes that humans are rational beings and will act to maximize their goals.

However behavioral economists believe that the markets are inefficient and human beings are not rational beings.”

then the author, give the examples

the author says, ” Consider the examples if you and I were walking down a busy street in Colaba and you said you saw Rs. 5 coins on the road. I would say it is impossible. so many people walk this read and the markets being efficient someone would have definitely picked it up.

But in reality, we do come across such instances. this shows that the markets are not as efficient as they seem to be further, if we assume that people make rational decisions to maximize profits then how do we explain people giving to charities or throwing a party to celebrate a birthday or an anniversary?

Definitely, this is not about maximizing profits by rational people.

here’s another example of how irrational we can be. the acronym Tips:- stand for To Insure prompt service

If TIPS ensures good service we should be tipping before the service starts. Yet, we give tips at the end of the meal. We even give tips when the service is substandard. (Stocks to Riches Chapter 4)

Tipping is more a custom, we do it mechanically unaware that we are behaving irrationally. yet, in economic theory we are rational beings always intent on maximizing our economic status. this is a common mistake we make without realizing its pure economic implications.”

after this, the author explains behavioral finance and why we react like this.

the author says, ” Behavioural finance researchers seek to bridge the gap between classical economics and psychology to explain how and why people and markets do what they do. Behavioral finance raises a couple of important issues for investors. the first is whether or not it is possible to systematically exploit irrational market behavior when it occurs.

The second issue is how to avoid making sub-optimal decisions as an investor. the goal is to close the gap between how we actually make decisions and how we should make decisions.

Hold on to stocks, that is crashing
Sell stocks that are rising
Ridiculously overdue and Underdue stocks
jump in late and buy stocks that have peaked in a rally just before the price declines.
Take desperate risks and gamble wildly when our stocks fall.
Avoid taking the reasonable risk of buying promising stocks, unless there is an absolutely ‘ assured ‘ profit.
Never find the right price to buy and sell stocks.
Prefer fixed income overstocks.
Buy when we have to sell and sell because others are selling.

then the author explains, how psychology plays a wonderful role.

the author says, ” Psychology can play a strategic role in the financial markets, a fact that is being increasingly recognized.

Students and proponents of behavioral finance create investment strategies that capitalize on irrational investor behavior. They seek to identify market conditions in which investors are likely to overreact or under react to new information,

These mistakes cause underpriced or overpriced securities. The goal of behavioral finance strategies is to invest in or disinvest from these securities before most investors recognize their error, and to benefit from the subsequent jump or fall in prices once they do.”

then lastly author gives the three sources of Alpha for superior performance.

i think you should read this in the book, for buying the book, visit the following link

so this is all about the Introduction of behavior finance, from chapter 4 of the book Stocks to riches.

Ways of Investing

January 9, 2022 by Laxman Sonale Leave a Comment

Hello, friends in today’s article we see chapter 3 from the book, Stocks to riches. In this chapter, we learn three ways of investing. let’s see them one by one.

Previous Chapter

Three Ways of Investing:-

there are three ways by which an investor can invest to achieve superior results.

1) Intellectually Difficult

2) Physically difficult

3) Emotionally difficult

let’s see first is an Intellectually difficult path

The Intellectually Difficult Path:-

the author says, “An investor like Warren Buffett, Charlie Munger, John Templeton, and a few others have taken the intellectually difficult path of beating the markets. this path is pursued by those who have a profound understanding of investing can see future trends clearly, and can comprehend business and the environment. they know that Patience is a virtue and therefore take a long-term position.

We admire them but usually in retrospect initially, we may see them as being misguided but that is only because of our inability to grasp their point of view.”

then the author explains the method that helps this big investor to become big.

this method’s name is cashflow.

Those are big investors, they see how businesses work, their economic policies and market forces that affect the business environment, and how businesses show the cash flow. So this is the most difficult path, and it required a keen mind to study the different concepts of investing.

the author says, ” A good grasp of the various fields of management is required to understand the organizations and their ability to capitalize on various business opportunities. Good knowledge of the field of liberal analysis is basic to the development of various investment concepts.” (Ways of Investing)

then the author explains the name of the game in investing to get a superior return.

the author says, ” Here the name of the game is Patience. Such investors are always on the lookout for good opportunities and bargain prices. As long-term investors, they are willing to wait for them. they are not perturbed by events news rumors and gossip that create short-term volatilities.

They have a strong belief in their abilities since their goal is investing long-term for cashflows. As against capital gains, they are in no hurry to invest. They strongly believe that opportunities are always there but that when the biggest of them come, one must have the money to invest.

They are therefore very careful about allocating resources. They never buy on impulse. They can be out of the market for months, even years. they have the patience to wait till the right moment. Brokers usually do not like such investors as they do not churn their portfolios regularly.”

Then the author explains Intellectually investor qualities.

the author says,” Intellectually investors are also emotionally strong. that is the reason they are able to exercise such restraint.

we all want to be such investors but we cannot as we believe that we are not allowed intellectually blessed as they are. This is a wrong notion. the reason they are intellectually capable is that they work hard and make effort to reach that stage.

They constantly explore opportunities by talking with management, examining different viewpoints on business, trying to understand economic policies and their effect on business environments, etc.

their intellectual capability is derived from their hard work and their strong belief in the long-term approach to investments. Moreover, they use common sense in their judgments and are not swayed by rumors.” (Ways of Investing)

so these types of intellectual qualities you should practice to get a superior return.

then author talk about the second difficult path is The physically difficult path,

The Physically Difficult Path:-

then the author explains, how we have to do work physically to get the proper investment opportunities, for that author gives the following explanation.

the author says, ” Most people are deeply involved in the physically difficult way of beating the market. they come early to the office and stay late. they do not know what their children are doing as they don’t have time for them.”

the author explains the whole things that regularly fund manager does each and every day of life. And this type of doing is the same as the other fund manager is doing.

then the author explains, why these people do this, and also gives their own experience on the physically difficult path.

the author says, ” In my experience, in the stock market dealing with fund managers has been really amusing. they sincerely believe that keeping themselves busy this way makes them look important and increases their ability to pick up the winners. Once I was at the office of a fund manager and we were chatting informally The telephone rang but he did not answer it. after a couple of rings, the call went to the answering machine. This is how most of them behave. show the world they are busy.”

then author explains how the day trader has also a physically difficult pathway.

the author says, ” the day traders also take the physically difficult path of investing. they spend the entire day collecting information and making decisions based on that information. (Ways of Investing)

so, with all the fund managers and the day trader trading the same path, how can any one of them achieve better results.?”

then author explains how good opportunities come, and what we have to do physically difficult path.

the author says, ” Good opportunities come once in a while and you spot them only when you are cool and have the time to think. The physically difficult path is based on the assumption that there are a lot of opportunities out there and you have to keep digging hard to be successful at investing. the current volatility in the market is the result of too many people trying to invest by this method.”

Life is simple. we make it complicated.

then the author explains the third difficult path and its most important and difficult path, if you master this way of investing then you are 90 percent ready to get a superior return.

The emotionally difficult Path:-

the author says, ” Most of us may find the intellectually and the physically difficult paths too daunting. In that case, we could opt for what is called the emotionally difficult path. Actually, this path is very straightforward. Simply work out, a long-term investment policy that is right for you and be committed to it.”

then the author explains how people think and act on the television news and rumors happening in newspapers, you can read, by ordering this book, link in below image.

after this author gives one example

the author says, ” If one were to compound money at a modest rate of seven percent the money would double at the end of 10 years and it would be 16 times at the end of 40 years.

Patience also helps you to control transaction costs. the more you churn your portfolio the more you pay the broker in terms of brokerage and of course the government in terms of taxes on your capital gains.

then you also have costs like depository charges, transactions tax, and service tax. all these costs would be avoided if one has Patience.

The emotionally difficult path requires an understanding of how our emotions guide our decision making especially when we deal with money. Our emotions directly affect our decisions on investments and expenditures.

We have to learn to think with our emotions rather than have our emotions do the thinking. understanding our own anomalies as also that of others will help us become better investors.” (Ways of Investing)

In the next fourth chapter, we will learn how to use our emotions to our benefit.

lastly, the author explains why is investing so difficult.

Why is investing so difficult:-

the author says, ” the most difficult part of investing is understanding the behavior of the stock markets. Market fluctuations are based on the varied opinions expressed by its participants, which in turn are subject to change commensurate with the changing sentiments of people.

it’s the crowd behavior that dominates the decision making and it is responsible for the sudden changes in the sentiments. take for instance.

The black Monday in May 2004. the markets lost around 700 points when the elections brought Congress to power.

What precipitated this huge fall? had anything gone drastically wrong with the performance of the companies whose stock prices crashed?

Definitely not. but the sentiments changed the BJP being voted out of power was a big change and normally we do not like changes.

Hence there was gloom all around and people dumped stocks as though there was no future. The herd mentality was at work and the markets crashed as each one wanted to get out faster than his neighbor.

If you were emotionally strong and you had bought when the others were panicking, you would have ended up making a huge fortune. (Ways of Investing)

But this seems easy only in hindsight. At that point in time going against the crowd is the most difficult but the most sensible thing to do. Understanding behavioral science is the key to success in this financial market. Its application not only helps you control your emotions but also helps you to understand others’ emotions and benefits from their mistakes.”

On emotion, Warren Buffett has a quote

“ If you can’t control your emotion, then you can’t control your Money”

so emotion is the main part of investing.

so this is all about the ways of investing from the book, ” Stocks to riches ” by Parag Parikh

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Investment strategy:- Stocks to Riches Chapter 2

December 30, 2021 by Laxman Sonale 2 Comments

Hello friends, in today’s blog, we see Investment strategy from the book Stocks to riches chapter 2, this book was written by value investor Parag Parikh. so in this chapter 2, we see investment strategy and the difference between investment and speculation. so let’s see one by one strategy.

Previous Chapter 1

Investment Strategy: Investment and Speculation

In this chapter, the author explains investment strategy and the difference between investment and speculation.

the author says, ” Investment strategy is the first issue that investors should consider. Investing is an act of faith, a willingness to postpone present consumption to save for the future, thus investing for the long term is central to the achievement of optimum returns for the investor.

there are two sources of returns in the stock markets:-

Fundamentals are represented by earnings and dividends.
Speculation is represented by the market’s valuation of these fundamentals.

then the author ( Parag Parikh) explains in detail above two sources of return.

the author says,” the first is reliable and sustainable over the long run; the second is dangerous and risky. these lessons of history are central to the understanding of investing. these two sources of return could be further classified into cash flow and capital gains.”

After this, the author explains what is Cash flow and how we have to consider ourselves.

Cash Flow concept:-Investment strategy:- Stocks to Riches Chapter 2

the author says, ” When one believes in the fundamentals of investing, one is looking at the dividend payout of the company. these arise from the company’s earning potential, and are possible, only when the company has a positive cash flow. this cash flow is a product of the fundamentals or inherent strength, of the company, the sustainability of the business, and the robustness of the business model.

along with that, there are other variables such as the quality of the management, competitive market position, core competencies, etc. Investing in such companies enables the investor to earn a regular income over many years.”

then, the author explains investment value.

the author says, ” the investment value of a stock is the present worth of all the dividends to be paid upon it. this is best explained by John Burr Williams, ” A stock is worth only what you get out of it. A stock derives its value from its dividends, A cow for her milk, a hen for her eggs, bees for their honey, and stocks for their dividends.”

then the author explain capital appreciation,

the author says, ” the capital appreciation that takes place is seen primarily from the angle of bonus and right shares, which in turn increase the shareholding leading to higher dividends. As a result, the shareholding cash flow is augmented.

The rise in stock price is secondary as there is no intention of selling for capital gain. It is only satisfying to know that one can cash in on such a huge appreciation in times of need.

When investors follow this cash flow model of fundamental Investing. it is always based on the premise that over a long period, the stock markets will go up irrespective of the turbulence.

For them, the bull and bear markets are part of the investment process. on the contrary, they wait for a bear market, as they are able to get bargains there is also a strong belief that equity investments are the best hedge against inflation.” (Investment strategy:- Stocks to Riches Chapter 2)

You all know, nowadays, there is huge inflation, so if you want to beat inflation, then equity investment is best.

then the author talks about the Capital Gain concepts, and what is the benefit of that, and how can we use them for our purpose or goal in life?

Capital Gains Concept:-

The author says, ” When a stock goes up in value and one sells it at a profit, that gain is known as a capital gain. When people buy stocks in the belief that the prices will go up and they will be able to make a profit, it is known as speculation.

the price of a stock listed on the stock markets reflects the value of the fundamental. Speculators bet on the market value of the fundamentals. Now there are traders and speculators who buy and sell stocks according to their perception of the correct price of the stock based on the fundamentals. Say a company like Colgate is quoted at a price of Rs. 145.

A trader may feel that according to the fundamentals of the company Rs. 145 is a low price and that the stock could go up so he would buy that stock at Rs. 145. when it goes up he makes a profit, which is his capital gain, if it goes down he makes a loss.

Stock price movements take place for a variety of reasons and the investor is vulnerable to a host of uncertainties yet he is willing to take the risk. Here people are not looking at the fundamentals of a company.

they are looking at the stock price going up because of probable factors, Such as the fortunes of the company changing, expectations of higher profits a technological breakthrough, etc. they buy and sell stocks on information or an opinion or a rumor. the idea is to benefit from a price movement.

the inherent gambling instinct in a human being is responsible for the huge turnover in this kind of speculation.

speculation perse is gambling. In the stock markets, the other name for speculation is trading. it gives some credibility to the process and also has a different tax treatment ( the basic difference between speculation and trading is that in the former no delivery of the stocks is taken and in trading, the delivery is effected.

The capital gains model is based on the premise that stock markets always witness bull and bear phases; one follows the other. For speculators and traders, the trick is to take advantage of the ups and downs of the market,

Volatile stock price movements excite them, they follow the short-term approach. They strongly believe that since markets always fluctuate, a long-term strategy is useless. In fact, during the tech boom, I interacted with some experts and fund managers who held the firm view that the old ways of investing were out as the rules of the game had changed. (Investment strategy:- Stocks to Riches Chapter 2)

To buttress their claim they cited the example of how warren Buffett missed the tech boom. today I know for sure that all of them are nursing their wounds, this is what short-term success does.”

then the author explains why warren Buffett missed the tech boom, and why they are so successful.

the author says, ” Warren Buffett’s success till date is due to the fact that he would refrain from buying business he did not understand. He would buy stocks that were quoting a discount to their intrinsic value, and he would buy businesses from which he could visualize sustainable earnings over the long term. As the tech stocks did not fit in with these conditions he stayed away from them.”

Then the author gives the case study of Infosys companies.

I think you should read this case study, by buying this book from the following link

then the author says ” let’s sum up, let’s take the example of a cattle farm and a dairy farm. In a cattle form, the asset is the cattle, cattle are bred and reared to yield good value when they are sold to the slaughterhouse. this is what is speculation and trading. You buy on the asset, wait till the price, Increase, then sell it off in the market for a profit. this is how capital gains investing works.

on the other hand in a dairy farm, the asset is also cattle, here too the cattle are bred and reared but they are not sold to the slaughterhouse. the cattle have long-term use, they are used to obtain a regular supply of milk.

In both cases, the asset is the same but it is used differently one for meat and the other for milk. similarly, in the investment world, some people used stocks for capital gains by trading while others use them. Stocks for cash flow by investing long term.”

then the author explains the law of the Farm

The Law of the Farm:-

Then the author explains how to make money in the stock market, by applying the simple law of the farm.

the author says, ” Stock market investing is all about managing the rewards associated with the risks undertaken. without risk, there is no return. Invest you must but before that, you must bear in mind the law of the farm. You reap what you sow but the crop is also subjected to the changing seasons. the seeds have to endure summer, rain, winter, and spring before it turns into full-blown tree. Stock market investments also work that way. there are no shortcuts if we invest in the right stocks with the right business model and fundamentals, over the long run we are assured of optimum returns. However, to do this requires patience and we have to go through the ups and downs but it is important to stay the course. (Investment strategy:- Stocks to Riches Chapter 2)

Getting carried away y the greed of quick returns ultimately destroys wealth as it does not conform to the law of nature. Many of us forget that nature and society are one.”

then the author gives the best strategy of investment.

The Best Investment Strategy:-

the author says, ” There is nothing wrong with speculation as such on the contrary it is beneficial in two ways, Firstly without speculation untested new companies like Infosys, Satyam, and in earlier times companies like Reliance, would never have been able to raise the necessary capital for expansion.

the tempting chance of a huge gain is the grease that lubricates the machinery of innovation.

Secondly, the risk is exchanged every time the stock is sold and bought, but it is never eliminated. when the buyer buys a stock. He takes the primary risk that the stock will go down.

However, speculating can go wrong if people.

Do not understand the difference between investing and speculating.
Speculate without the right knowledge and skill.
Speculate beyond their capacity to take a loss ( that is called margin trading.)
The Greatest problem today is that most investors are acquiring speculative habits believing that they are investing.
The Attraction of quick money and the advent of the futures market have lured them to margin trading. for a number of people, this has become a full-time occupation due to the advent of the internet and online trading. This could be bad news especially when they are dealing with their life savings. “

then the author explains the risk Reward ratios.

Risk-Reward Balance:-

the author says, ” the important thing to remember is that investing is all about risk and Reward and vice versa.

the investor needs, to select the right balance when choosing investment vehicles and the strategy.

During the IT sector boom, the stock prices of IT companies were going up by leaps and bounds and people were buying such stocks at any price thinking that the price would go up. There was no rationality as to the value and the price. People were thus only buying risk, there was no effort to balance the risk-reward ratio. (Investment strategy:- Stocks to Riches Chapter 2)

We all know the fate of various IT Investors when the markets crashed. In March 2003, when the Iraq war was on, the markets were vert down and some of the stocks were available at ridiculously low valuations. the dividend yield was also very high. the price to earnings (P/E) ratios was attractive. This was the time to invest in Good Stocks as one would be only buying reward and the risk would be minimal. The risk-reward ratio would be in the investors favor.”

so this is all about how much you take risks with companies fundamentals, not speculative manner, that gives the high rewards.

then the author explains long-term investment.

the author says, ” Here are certain facts which prove the point that long-term investment is very rewarding and that patience is a virtue in equity markets. Three companies ( and there are several others), that have given excellent long-term returns to investors who bought stocks over a decade ago and held on to them, are Hindustan lever, hero honda, and Infosys.

The Hindustan lever has given a compounded annual growth rate ( CAGR) of 21 percent in returns for the last 13 years, whereas hero honda, has given 41 percent CAGR to shareholders on their investments during the same period. Infosys has delivered an astounding 79 percent annual return to shareholders since its listing 11 years ago. All these figures include dividends. as we can see this is higher than the returns available in any other investment avenue like bonds or bank deposits. (Investment strategy:- Stocks to Riches Chapter 2)

However, this does not mean that these stocks have only gone one way that is upwards.

They have had pretty serious declines at various points in time but despite that, the long-term result from owning them has been impressive.

The Hindustan lever has been falling for the last two years, Infosys had a very sharp decline after the bursting of the bubble in technology stocks and Hero honda also fell significantly in early 2003 when its quarterly sales slowed down.

Short-Term investment can also be rewarding for the speculator who is able to take risks and time the markets. Take the case of a speculator who had bought Infosys, at Rs. 2000 when the market started moving up and sold it when it went to is 13,800 within a year and a half. He made tremendous gains and he laughed at the investor who hold on to the stock since the beginning and got a return of 79 percent CAGR.

a Speculator could have short sold Hindustan lever at Rs. 210 in November 2003 and recovered it at 4,120 in august 2004 making a return that even a long-term investor in Hindustan lever would envy.

Speculators do make a killing, as some would have definitely done during the various periods of the boom and the bust cycles. the only rider is, can they do it consistently over time! A lot of speculators could have made more money than the long-term investor on the above stocks.

So it is different to say which strategy is good and which is bad. It depends upon the individual’s mental attitude, discipline, risk-taking ability, and patience.

from the above paragraph, some points conclusively prove

Long-term investing can be very rewarding if you buy the right company at the right price.
a stock can decline significantly in the short run and yet give a decent long-term return.
Short-term investing ( speculating) can also be very rewarding if you are able to time the markets and take advantage of short-term volatility.

As we can be seen from the above table even though the net profit of Infosys has grown it 43 percent CAGR, 2000-2004 the market capitalization has fallen by 14 percent CAGR in the same period.

This is the impact on investors when a good business is bought at irrational prices. the P/E ratio has continuously declined. (Investment strategy:- Stocks to Riches Chapter 2)

So if one had bought the stock at a higher price in 2000 he would be losing money in spite of the company showing improved performance, this is the risk one takes when one is speculating.

Most of the IT experts and fund managers ignored Benjamin graham’s words of warning. ” Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

In today’s changing times there is so much uncertainty that looking at the long-term approach seems unviable. Hence the stock markets have become the bedrock of brute speculation.

this is the reason for so much volatility. It is also turning long-term investors into short-term punters. this is how the investment world works today. If you want to be a successful investor there are three ways of investing Chapter 3 looks at the best way to invest.

so this is all about chapter 2 from the book Stocks to riches by Parag Parikh

If you want to earn a lot of money in the stock market, you must read this book. This is only of my favorite book, so when I was looking I am away from my value investing strategy, then I read this book, and again set my mindset as a value investor.

this book explains wonderful investment strategies, be read continuously.

Investing Books

Chapter 11:- Why must one Invest:-Financial Literacy

Learning the Money Game:- Financial Literacy

Cash flow of the Middle-Class People:

Cash flow of rich people:-

Chapter 10:- The Stock Market Bubble formation

System Thinking:-The Stock Market Bubble

The Psychology of Stock Market Participants:-

Governments:-

Regulator:-

Stock Exchange:-

Brokers:-

Banks:-

Companies:-

Mutual funds:-

Media:-

Investors:-

Operators:-

Making the Bubble:-

Chapter 9: Mutual Funds: an Idea where time has Gone

The Beginnings of Mutual funds:-

The Paradox:-

Fund Manager’s Behaviour:-

Destructive Environment:-

Mutual funds: A profession or A Business

Mutual funds solution:-

Mental Heuristics:-

Availability heuristics:-Mental Heuristics

Representative Heuristics:-

Saliency Heuristic:-

Herd Mentality:-Mental Heuristics

Size Bias:-

Mental Accounting:- Stock to riches Chapter 7

Earned Income V/s gift Income:-Mental Accounting in Stock market

Quantity of the money in Question:-Mental Accounting in Stock market

Large Purchases V/s Small Purchases:-

Cash V/s Credit Cards:-

Sacred Montey:-

Impact of mental accounting on Investors:-

Decision Paralysis and The endowment effect:-

Taking Decisions:-

Investing And Decision Paralysis:-

Endowment Effect:-

Impact of Endowment Effect:-

Overvaluing One’s Holdings:-

The Trial and Money-back Guarantee scheme:-

Loss Aversion & Sunk Cost Fallacy:-

Impact of Loss Aversion:-

Sunk Cost fallacy:-

Impact of Sunk Cost Fallacy:-

Introduction to Behavioural Finance:-Stocks to Riches Chapter 4

Classical Economic theory V/S Behavioural Economic theory:-

Three Ways of Investing:-

The Intellectually Difficult Path:-

The Physically Difficult Path:-

The emotionally difficult Path:-

Why is investing so difficult:-

Investment Strategy: Investment and Speculation<img decoding="async" style="border: none !important; margin: 0px !important;" src="https://ir-in.amazon-adsystem.com/e/ir?t=laxman0a7-21&amp;language=en_IN&amp;l=li2&amp;o=31&amp;a=0070597715" alt="" width="1" height="1" border="0" />

Cash Flow concept:-Investment strategy:- Stocks to Riches Chapter 2

Capital Gains Concept:-

The Law of the Farm:-

The Best Investment Strategy:-

Risk-Reward Balance:-

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Financial Literacy

When to Buy Stock ( by Philip A. Fisher)

Loss Aversion & Sunk Cost Fallacy Bias

Sources of Information about Company

Mutual Funds:- Good or Bad?

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