Read this before deciding your 2018 investment strategy

What a week for the markets! Drama from the Gujarat elections injected volatility, but overall stocks rose dramatically through the week. 82% of stocks listed on the NSE rose during the week. To put it another way, for every stock that declined, nearly five rose during the week. The markets are up nearly 30% in the last year and some stocks have outperformed indices by several orders of magnitude. No wonder that the investment industry is India’s true sunshine sector currently.

As if on cue, more than a handful of experts can’t stop but wonder aloud about the sheer brilliance of their picks. Twitter is currently awash with tweets about cyclical themes, sectoral plays, fanatical promoter-founders strategies, rural growth themes and many more.

Celebrity PMS fund managers are on the financial news channels talking of triple-digit returns in just 6-9 months.

Let’s face it. Not all of us have chartbuster returns to show for 2017. If you weren’t holding the likes of Rain Industries (5.6x), Avanti Feeds (4.3x), Bombay Dyeing (3.5x), Dilip Buildcon (3.2x), Minda Industries (3x), your returns for the year probably look “relatively” pedestrian. And we know (though we don’t care to admit) nothing is more frustrating than to watch other people make money faster in the stock markets.

So when the brilliant stock pickers (which sometimes seems to be everyone but you) talk about their next set of brilliant stock picks for 2018, we can’t help but take serious note.

Before you decide to tear down your current investment philosophy whatever that may be, to start coat-tailing celebrity investors, let’s do an experiment.

How would you have done if you had selected 10 completely random stocks in December last year?

The idea for a random portfolio builder is directly influenced by Capital Mind’s Magic Portfolio, albeit more crudely executed here.

I created a google sheet with the list of 501 stocks that make up the NSE 500. Then picked 10 stocks randomly (monkey throwing darts approach) assuming an equal-weighted portfolio, compared its results against the NIFTY. The point of the exercise is to repeat the exercise multiple times to see how the portfolio performs relative to the NIFTY.

And finally, a look at how the portfolio performed over the year. Mouse over the chart to see values.

The one instance shown here means nothing which is why you can run this analysis with multiple portfolios by copying this google sheet here.

You will likely find that almost any random combination of 10 NSE500 stocks a) would have given decent returns for the year and b) most likely would have beaten the NIFTY by quite a distance.

Hard to believe? Try it out for yourself. Instructions for creating random portfolios are on the sheet. Play around with it to see for yourself.

Maybe some fund managers showing exemplary returns were in fact brilliant in their stock-picking, but in a market where randomly picked portfolios also perform well, how do we separate plain luck from stock-picking ability?

It is during heady times like these that the investor needs to stay focused on improving the process, to remind herself of foundational concept of mean regression and not be distracted by envy of supernormal returns.

Like the eloquent Mr. Khambatta put it

Let me know how your random portfolios do and whether they make you wonder less about the selectively stratospheric returns of others.

Further Reading:

The magic portfolio builder that beats the NIFTY Capital Mind

4 thoughts on “Read this before deciding your 2018 investment strategy

  • December 24, 2017 at 12:47 am

    Nice!! Not sure if this is an appropriate analogy but this is somewhat like the placebo effect in medicine. .. Your headache is getting better because you popped a pill.. Doesn’t really matter what pill!! You stocks are winning simply because you bought some stocks, not necessarily any particular combination of stocks.

  • December 24, 2017 at 4:54 am

    Well put Ashok. Also helps to understand the same applies when someone else talks of supernormal returns 🙂

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