Mental Models are a must to make money in the market. And if you think otherwise, let me tell you an interesting anecdote from my experience.
“It was mid-2014, and the new government at the center had big plans for the electrification of the whole of India. And I, very much convinced by the thesis wanted to make some quick bucks in the market.
I researched a bit here and there (mostly on online blogs, forums, and screeners) and found a micro-cap stock in the cable manufacturing industry. Having recently got permission from Dad to put no more than 5000 from my salary in the stock market. I took the plunge and bought the stock at Rs. 30/-.
I had convinced him that, this will definitely beat the bank returns (around 9% at that time). But he was still skeptical, because of the subpar return from the ULIP fund I told him to buy in Oct 2008 (a good time to buy in hindsight, but a bad product to buy).
But this time, it was different, the next day, I log in to my trading portal, and the stock was up 11% (beating the whole year's bank return in mere 18 hours). Like a newbie in the market, I was pumped up, I straightway called him and said, here I beat your bank returns.
He was still coming to the terms of unexpected gain in a day and said until I sell, it’s not guaranteed. So I squared off my position and showed him my profit, a handsome 300 rupees (excluding charges).
I don’t even remember, what I did with that money but the point I wanna make is that the stock was KEI Industries.
You will realize how bad that sale was after looking at the stock charts, now almost 50X from that price.
If I have used the mental model, I am going to explain now, I would have not only made at least 30X from the stock but added more of it along the path.
What’s the basis?
The basis of any mental model stems from the fact that it is very easy to get stock names in the stock market but very tough to make good money out of them.
Late Rakesh Jhunjhunwala, the eternal bull of the Indian stock market, had said this many times, everybody knew his public stocks, but no one could make money like him. “You will get stock name, but where will you get the conviction to hold?”.
Mental models help you build conviction in stocks and thus make real money.
I came across various models in the last decade but realized that not every model works for everyone. Also, some of them are complex and layman folks have a tough time understanding them, so I devised a new one so that I could explain it easily to my Dad.
My dad had an agricultural background before he made a name in the steel sector. So it made a lot of sense to explain things to him in agricultural analogy. And thus I named it the Money farming technique.
What’s the technique?
The technique treats each stock as a potential farming asset, broadly as…
Trees
Plants
Crops
And what is the land? the country business space is the land. So virtually, you have a vast amount of land available, all you need to do is to pick the right assets and hold them for an ample amount of time to make a good harvest.
Once you understand the basic principle, every time you pick up a stock for investment, put it above classification. For example.
1. When I picked up ITC in mid-2020, I put it in the category of Trees,
Reason: It has a stable business(strong roots), doesn’t need new cash to sustain operations(less water), and provides dividends regularly (fruits).
2. Picking up FIEM industries, was like putting up a plant.
Reason: It has a relatively newer business and needs constant cash to increase business, also the business dynamics (environmental effect, strong winds, draughts) can hit it, and prices can drop like anything (dropped almost 80% in the 2016-2020 period). Need constant care, and nurturing to grow, just like a plant.
3. Picking up stock like Voltas, was like putting up a crop.
Reason: Seasonality put up a strong point(buying in winter, selling in summer), there is clarity on business, everyone is very much aware of it, strong brand and support system are available. Periodic harvest can be taken.
Of course, one stock can come in different categories, but once you put them in classification, you get multiple advantages.
You know, when to sell. Crops can be harvested periodically, Trees can be cut when old enough or fruits are not useful, and Plants should never be cut until you have better plants to put in.
Conviction and investing become peaceful, you expect volatility, you expect performance, you expect sluggishness and when you are mentally prepared for it, voila you get what you wanted.
Patience, when you know when to expect things, you have patience, for example, if you put a rice crop in July, you will expect to harvest it by Nov-Dec, since you understand that, if you harvest by Sep-Oct, the crop will be unripe, or if you harvest by Jan-Feb, the crop will be stale.
Does it really impact you?
The real return a retail investor makes from the stock market is a mere 1.9%.
And now you know why? Because they lack a model to invest.
So if you lack a model to invest in, you are better off with real estate and gold rather than doing stocks on your own. They are far simpler and easier to hold in. And the simple reason is the mental model you have for gold or real estate.
When you buy land, you don’t see its price going up and down daily, and that gives you mental peace and thus a greater conviction to hold.
For example, my Dad bought a piece of land in 1982 for Rs. 1600/- in my ancestral village, now the price for that piece of land is 200x in 40 years. Great return isn’t it? But during the same period, Wipro grew 12,000x.
But holding the piece of land was far easier than holding Wipro would have had it. So eventually it all boils down to the mental model you are accustomed to.
Personally speaking for me, moving from random buy/sell to the money farm technique had made an amazing impact. Returns have definitely improved (mostly because I got lucky with the market low) but that’s not the point. The actual impact, it has made on mental well-being.
The stress of open positions has reduced dramatically. When you have only one plant to tend and it performs poorly, it’s obvious to get worried, but when you think of a scheme of farms, one plant going bad doesn’t affect the farm at all.
So advantages of moving to a mental model are real.
How do I make a switch?
The effectiveness of the mental model comes in really handy when the market is under stress or you have things going wrong in your life. So if you don’t think a switch is needed now, wait for the crisis to come and then decide.
And for those who are convinced, you can take simple steps to make a gradual move toward the money-farming technique.
First, list down your current investment and map them to farm assets like trees, plants, or crops. Don’t worry if things don’t fall in place at first, but gradually they will.
Clean up, any unwanted investment that doesn’t fit into any of your categories. You can also make new categories like I had something called weeds (useless plants that grow during farming). Gradually clean up all weeds from your farm.
Any new investments you wish to make should align with your investing philosophy. Invest and tend it like you would manage tangible farm assets.
You can also take professional help for the same.
What is a Mutual fund then?
A mutual fund is akin to pooled farming, where there are professional folks, doing all the hard work and in turn, charging a minuscule fee. It’s a great wealth-creating technique since the decision of farming assets totally lies with professional people and you just have to put in the money.
So if you are not yet comfortable in the stock market, start with mutual funds. Put the majority of money in those funds, and the minority (around 5-10%) in stocks.
Spend some time with those stocks, gain confidence and once you get hold of it, start increasing your investment in stocks.
Hope you have enjoyed the technique, if you liked it, please share for greater reach.
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