(The following is from an article I wrote for a financial magazine in early 2011)

One of the most fundamental tenets of investing is “Buy low, Sell High” – very common sense, and seemingly sure way to make money. But anybody who has invested in the stock market or any asset class for that matter – real estate, and now gold, silver – knows how difficult it is to practice. In Warren Buffett’s words “Investing is simple, but not easy.” The reason is basic – investing is not a science, but an art. Investing encompasses lot of emotional aspects – which are magnified by volatility of the markets, behavior exhibited by investor friends & colleagues, and constant news flow by the financial media.

Even experienced and professional money managers are not immune to such behavior – and are perhaps even more prone to such behavior given the superior access to information tools and an inherent bias for action in one’s own full time profession. Since Equities are an excellent investment avenue over the long term, how should an individual investor invest in a manner, which has high probability to create wealth, but does not require extensive time requirements?

SIP (Systematic Investment Plan) is often recommended as an excellent method to overcome biases and tendency to time the market. SIP is based on three basic premises – first, it is impossible to time the market. Second, in the long term, underlying earnings of the companies will trend upwards and so will the direction of the market. Third, buying more number of shares in down markets and buying less number of shares in up markets will result in lower cost of acquisition and will lead to superior profits. We must say that all three premises are based on fundamental facts. To back test it, we have used past data of BSE Sensex, available on BSE website, for the period Jan 1996 – Dec 2010 (15 years), by taking only the month end data (180 data points). By investing Rs. 1 lac every year (Rs. 8,333 per month at month end Sensex value) during this period, one would have made 3.9 times the money invested by the end of period i.e. Dec 2010. Starting in Jan 1996, when BSE Sensex was at 2,932, an investment of Rs. 8333 would have yielded 2.84 units of BSE Sensex. Similarly, an investment of Rs. 8333 in Dec 2010 at BSE Sensex value of 20,509 would have yielded 0.41 units of BSE Sensex. The cumulative value of this Rs. 15 lac investment would have been Rs. 59,12,375, a satisfactory return by any standards. While the simplicity of the approach makes it easy to follow, it forces one to invest even in irrationally high markets.

But can we improve this? How does the basic principle of “Buy low, Sell High” fit into this? Let’s first consider the “Buy low” part – let’s call it iSIP (Intelligent SIP). If one considers the past 15 years of BSE Sensex data on BSE website, trailing Sensex P/E has ranged between a high of 29.4 (June 2000) and 11.9 (Nov 2008), with a simple average of 17.8 (again taking Month end data). Now, suppose one says “I want to invest only when the markets are cheap, so I will invest all the annual investment of Rs. 1 lac in the first month of the year when trailing market P/E is less than 14. If I don’t get such an opportunity in a particular year, that means markets are not cheap enough, and I will roll over this investment to next year till the time I get the market at trailing P/E of less than 14.” Sounds logical enough, invest heavily when markets are cheap and then just see money compound! With this approach, we would have invested a total Rs. 14 lacs on only 12 occasions (Balance Rs. 1 lac for 2010 is still pending). One would have missed investing anything in the years 2000 and 2007, and investments for these years would have been rolled to the next year. Given that we now know what happened after these two years, this strategy does seem to have some merits! Anyways, this investment of Rs. 14 lacs would have grown 4.8 times to a corpus of Rs. 66, 97,152. But given the discipline required to not invest any money in years like 2007, with great euphoria and cocktail talk of the stock market, and then investing lot of money during Oct 2008 with gloominess and former bulls turning into bears, that incremental return may not seem worth it.

Now, let’s add the perhaps more interesting “Sell High” principle to our investing strategy – let’s call it icSIP (Intelligent & Confident SIP). Now, one says “In addition to buying only at a trailing Sensex P/E of 14, I will sell all my holdings once markets start trading above a trailing P/E of 24. After all, selling is as important as buying, and I need to book my paper profits, before they turn into losses. So, I will sell when markets trade above P/E of 24, and then invest the whole amount when market fall to a P/E of 14.” So, in addition to above 14 buying opportunities, one has to do additional work of selling at 2 points of time. Grudge! Is it worth it? Looking at the data, it is definitely worth it. What were the two selling times – these were Feb 2000 and Nov 2007. Selling at these points, and then investing the whole amount when markets fell to a trailing P/E of 14 (Sep 2001 and Oct 2008 respectively), one’s Rs. 14 lac investment (Rs. 1 lac investment is still pending) would have turned into a whooping Rs. 1,65,98,008 (11.9 times). And all this money would now be cash, as we would have sold out in Oct 2010, and now would be waiting to invest in case markets….

Like any investment strategy, this strategy also has shortcoming – mostly behavioral in this case. It will demand that an investor be “Greedy when others are fearful and Fearful when others are Greedy”. It might mean selling early into a rapidly advancing market, when everybody seems to be making easy money. It might also mean investing with gloom and doom all around, and market experts predicting 10 year bear markets. It also has one serious implication i.e. for your broker – that you will make just few transactions. Though for some investors, it might mean being away from all the market excitement. Such investors can devote a small part of their portfolio to enjoy market excitement, and a large part to actually making serious money.