Let us consider today, 24th August 2016 as a rational decision day, and try to understand how to take sound investment decisions. Many investors invests their money in individual stocks or buy into mutual fund units.

Consider the following scenario: a fund manager launches a fund with capital from family and friend. In the first six months, the manager delivers a pleasing 20% returns, but then gives up almost 75% of its gains in the following six months, to end first year with returns of 5%. In the first half of the second year, bears are still under control and the fund continues its losses and lose another 5%. In the second half of the second year things start to turn around and fund captures gains of 20%. To keep it simple, let us assume that market in this two years was flat and delivered zero percent returns. Looking at market returns, the fund had outperformed.

Now, what do we make of the skill this fund manager had demonstrated?

Honestly, the first point I can make it out is that 2 years of track record is not enough to judge the fund managers skill. Our fund manager had given excellent returns of 20% in the past two years, but clearly there was significantly very high volatility and so luck plays a big role in shaping the numbers. If we would have invested in the mid of the first year, our returns today will be zero percent, we would have observed zero percent outperformance.

Wait, here is more.

Now imagine you were watching from the sideline the performance of the fund for the first six months, and decided to invest with this manager at the end of first half, having seen the good early results. Your experience with this manager will be painful series of losses over the next 12 months, at which point many investors would throw in the towel and withdraw their money.

Those that held onto their towel would have recovered to end square in the next six months, but we now have three different set of investors to consider: those that were there from the beginning, those that came late and left disappointed and those that came late and held on.

If we ask these three groups of investors to rate the skill of this fund manager, I can guarantee you that we will get three different set of answers, ranging from excellent to miserable, reflecting the particular investment experience of each investor group.

We can see that it is not rational to have three conflicting assessments of the skill of one fund manager but, human nature is being what it is, this is absolutely what happens.

A lot of investors unwittingly allocate themselves to the “miserable” group. It is very tempting to invest within the fund which had given strong returns in recent year, and then withdraw that capital following period of weakness. This mindset results in investor’s systematically buying high and selling low and achieving far weaker returns than they could with patient mindset.

To summarize, this is what we also do with individual companies, where we buy them because they are going up every single day, and they then start their downtrend from the day you purchased! Without having any idea about what valuations you are buying them. It is important to take long term perspective while investing in the stock market and avoid the short term “noises” to achieve higher returns.

With this in mind we will try to share new opportunities that are available in the market and share our opinion about that business.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise you to take professional advice before going ahead with our views.