Know the type of investor you are: A Social Investor or Real Investor? Exploring an untouched section of the stock market

Social means the one who makes people happy by their action. In the same way, it is believed, a social investor makes other investors happy and rich by entering in the rising market. Their investment decisions are purely based on rumors whereas real investors/rational investors buy stock during the bearish market at a cheap price and thus, become rich in the long run. The real investor's investment decision is based solely on research.

Consider this example, if an average P/E of NEPSE is 15 and let us assume that NEPSE's P/E fluctuates in the range of 10 and 20. Then, the real investor sells their stake at the time when the market is in the range of high P/E and buy when index floats around the lowest P/E.

We don’t mean that the real investors timed the market and after their exit market would lose 50% in the next 2 months. Instead, we intend to express that the real investor enter (or exit) with the inherent behavior of the market whereas the social investor enter only during the strong bull market.

Again, we are not assuming that after the entry of social investor market turns absolutely bearish. There is a possibility that they make money at the beginning. However even, if they make money in that period they won't be able to retain it as they increase their stake in a hope of large profits during that period and eventually end up empty when bull market ends.  

Stick with us we are going to explore some of the untouched points of the stock market in this article.

Now let's explain these things with a statistical figure

The average return of the NEPSE over last 24 years is around 11.06% and the neighboring country's major indices Nifty and Sensex has given a return of around 10.75% in 23 years and 10.72% in 25 years respectively.

We have to use S&P 500 index data to express our view due to the lack of data of NEPSE. The initial price of S&P is taken during the strong bull market before the great depression of 1931. If we had considered S&P value after the great depression of 1931, the average return would have been little higher.

The table above shows the dividend-reinvested average return of the S&P 500. The average annual return since 1928 is 9.62% and in the last 80 years, the return is near 11%.

We have also researched on the average returns in every 5 years of S&P 500 since 1928 and observed that the return in 5 years is not more than 22%. (Years for "five years return" is taken in the multiple of 5)

How to interpret and utilize this information?

The duration of 90 years is very long. The period of 90 years signifies that the two generation of investor behaves in the same way with the market.

Thus, we can expect the market to behave correspondingly as it had been behaving in the past.

On average the market had provided a return of around 10%. Now, if the market gives a return of 22% in five years then the chances that market will underperform in next 5 years is high as it has to give a return of around 10% on average. In this situation, we can sell our stake.

On the other hand, if the market provides a return of <5% in 5 years then it's a wonderful time to buy stocks.

Now coming to back to NEPSE, its average return is around 11% (dividend reinvested return of NEPSE will be more than 11%). The average return of NEPSE in the period of the bull market of 2011-2016 is around 41% and the last five years return of NEPSE is around 15%. After the bear market of 2008, the average annual return till 2013 is around (-22%).  By looking at this data we can say that the NEPSE is comparatively more volatile and currently it is trading above the average annual return of NEPSE (Comparing to last five years return).

(The numbers we have considered here are of approximate value)

This is one of the ways to deal with the period of an over-excitement and low-confidence in the market.

Now, how an investor can transform from the social investor to real investor?

1. Rocket science doesn't work in the stock market and there is nothing that works every time here. So an investor needs to analyze the behavior of the market and should understand the level of uncertainty of the market.
2. The decision should be made on the analysis. Impulsive decisions are not considered good in the stock market.
3. The investor should be able to analyze the financial statements of the company and be able to make a decision on an in-depth analysis of financial statements.
4. An investor should not move with the volatility.
5. A real investor avoids investing as per the rumors.

Investors who perform above analysis are real investors and if you want to be the real investor then you should practice the above-mentioned things.