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Experiencing Long Term Investing, One Short Term Period At A Time

While the actual water temperature remains the same in an absolute sense, you can trick yourself to experience it as either hot or cold based on how it is relative to recent experience.

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Imagine there are three bowls of water in front of you - one cold, one hot and another at room temperature. Assume you put one hand in the bowl with the cold water, and the other in the hot water for about a minute. Now put both hands in the bowl containing room temperature water. The water will feel cold to the hand that originally was in the hot water, and warm to the hand that was in the cold water. While the actual water temperature remains the same in an absolute sense, you can trick yourself to experience it as either hot or cold based on how it is relative to recent experience.

Now what does this have to do with equity investing?

Equity investing is for long term. Based on past history, the return expectation on which you are sold equities will usually be around 12-15%. This is a message that has been beaten to death.

Now the only issue is you don’t experience long term as a single point of experience.

You experience long term as the cumulation of several short terms.  

A 10 year return is psychologically experienced as:
520 weekly returns or 120 monthly returns or 20 half yearly returns or 10 yearly returns.

Equities is an extremely volatile asset class in the short term. This means the short term in which you live, measure and experience the asset class, most of the times will have returns far lower than your expectations. Unfortunately, you have already dipped your one hand into the “Equities will give 12-15% returns” expectations bucket. Add to it the other hand dipped in “Atleast FD returns” expectations bucket. As you measure the equity returns over the short run, and dip your hands into the actual short term returns you suddenly have a reality check vis-a-vis your expectations.

  • Less than FD returns - Disappointed (I would have been better off in an FD)
  • Negative Returns upto -10% - Anxious (The news is bad. My gut feel says it should fall further)
  • Fall extends from 10% to 20% - Regret (My intuition was right. I should have sold it much earlier)
  • Further fall - Panic (Let me get out and re-enter once the coast is clear)

This is exactly where the problem lies.

While our expectations are set for the long term, the short term experience is conveniently ignored.  Equities being a variable experience product in the short run, investors will also need to have a rough expectation of what to expect in the short run based on history.

Here is a simple way to do this.

Start setting 6 month expectations. I have not used the 1 year period as it might be too long in the current instant portfolio alert world. While even shorter time frames can be explored, six months is a decent starting point, as it is neither too short not too long.

Nifty 6 month Rolling Returns

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Tags assigned to this article:
personal finance

Arun Kumar R

The author is Head of Research at FundsIndia.com

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