Imagine your are a movie producer with Rs 10 crs.
You are allowed to produce 1 movie every 6 months.
~3 months to produce and 3 months in theater (hopefully).
There are 2 possibilities
- The movie is a flop and you lose money
- The movie is a hit and you gain money
The final amount (higher than Rs 10 cr if it is a gain or lower if it is a loss) is used to produce the next movie.
How will you approach this?
Wait. You have some questions..
Question 1: Usually what % of movies actually make money?
75% of the times, the movies have made money. The average gain was 20%.
25% of the times, the movies have lost money. The average loss was -10% .
Question 2: What is the normal loss when the movie is a flop and the normal gain when the movie is a hit?
Based on last 15 year history, 95% of the times the return outcomes have been in the range of -30% loss to +75% gain. It can be anywhere in this range.
Question 3: What is the worst case?
These are cases where the movie is banned due to some controversial content or some actor dies before completion etc. Historically the worst loss in such cases has been -60%!
Question 4: What is the best case?
The best case in case of a huge hit has been a gain of 106%.
Putting all this together..
1. Few movies will inevitably flop leading to normal losses
2. One in 16-20 movies will face a large loss (once every 8-10 years)
3. Majority of the movies will do well leading to normal profits
4. One in 16-20 movies will be an extraordinary hit and provide abnormal profits (once every 8-10 years)
5.The overall odds is in your favor:
75% of the times you make an average gain of 20%
25% of the times you make an average loss of -10%
Thus this leads to a simple profit making strategy
1.The odds are in your favor only if you produce a larger no of movies
You will need to produce a large no of movies so that you can take advantage of the higher odds of a hit movie. You will need to produce atleast 20-30 movies. At the rate of 1 movie for every 6 months, this implies a 10-15 year time frame.
If you are planning to produce less than 10 movies (a time frame of <5 years), then you are counting on luck. A few bad outcomes can leave you with permanent loss as you don’t have the time to recoup.
How to reduce the risk?
You can reduce the impact of declines by investing only a portion of your money in movies and remaining in Fixed Deposits or Debt Funds
You can split your money and instead of 1 movie (which was taken for convenience of explanation) invest across several types of movies (low budget, large budget, star heroes, women oriented, masala movies, new age movies etc)
Applying the approach to Equity Markets..
Now just replace the movies with a well diversified equity portfolio and read the entire article again.
(the above stats are for a 100% large cap equity portfolio)
Suddenly, does the boring strategy of long term equity investing start making sense?
What if you start thinking of equity market investing for the long term (say 10 years) as producing 20 movies, one every 6 months.
When market falls over a 6 month period, the movie is a flop,
When market gains over a 6 month period, the movie is a hit.
75% of the time, on a 6 month basis the market is up (i.e the movie is a hit)
So the key is to realize that few flop movies are inevitable.
But as long as you produce many movies, in the longer run your hits will more than compensate for the flops.
All that is required from you, is to execute the most effective yet understated investment strategy – PATIENCE
Happy investing 🙂
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