Sunday, 29 March 2015

Why You Should Be Wary of Long-Term Investing

It's always risky to challenge a belief that has wide currency among people. This is not only because we like to keep a tight grip over our beliefs, but also because by the time we realize the truth we may have already made a huge commitment and it is difficult to retract now. Nonetheless, it is always in one's interest to at least understand, if not wholeheartedly accept, the contrary perspective.

One widely accepted and sacrosanct belief is long-term investing. The financial community teaches the merits of long-term investing in unison. “Invest for the long term and you will do well”—this is the jingle which accompanies almost every statement that the financial community makes. Indeed, it has examples to cite that support the belief. The most frequently given example is of the market index, which has gained significantly over the long term. So, as the argument goes, if you had invested in the market ten years ago, you would have made fantastic gains. When you weigh the argument against reason, you have no other option but to believe it.

However, things aren't so simple. Consider the following points:

What if the long-term investing theory fails to work in your case? You are a long-term investor and you believe that everything will eventually turn out to be okay. What if you get a bad surprise after many years of having made your investment? Will you have time to undo the effect? Let's say you buy a financial product today and wait patiently for ten years to allow it to work. Ten years hence you notice that the investment has given paltry to no (or even worse, negative) returns, what do you do now?

The long-term investing idea is the ultimate cover-up for lack of performance: Your financial product isn't performing, but you hold onto the product because you are told that over the long term it will do well. You own the stock in a company which is doing poorly, yet you don't exit from it because you think that over the long term it will recover and deliver returns.    

The long-term investing idea relieves you from the responsibility of tracking your portfolio: Since you are invested for the long term, you don't make any decisions and justify your inactivity by saying that you need not make any decisions in the short to medium term. When you are investing in stocks, you are in the business world and you have to be periodically making decisions. You should be consistently monitoring your portfolio to determine what to buy and sell. You should be consistently monitoring your companies' performance. Now I am not saying that you worry about your stocks on a daily basis. All I am saying is you can't really set your hands off them completely for a prolonged period of time. That's a recipe for disaster.

Long-term investing can result in unnecessarily waiting for “better” results: Stocks don't always follow the long-term rule. A stock can very well appreciate in a couple of months and hit a high level. When the market is willing to pay you an excellent premium on your buying price, you should be willing to sell. However, the long-term theory keeps you from selling “early.” Unfortunately, as the bull run in the stock fizzles out and it goes down, you lose the opportunity. What's more, you still hang onto the stock as now you have seen it attain a higher level and you would rather wait for that level to arrive again—of course, over the long term.     

Your long-term mindset works in favor of the financial community: The financial community gets to keep your money for the long term. Its accountability for results also reduces if you believe in the long term. Warren Buffett, the iconic investor, had sold off all his stocks in 1969 as the valuations were rich. He stayed out of the market for around two years after that. Will a fund manager do so? He can't because the company wants the fund running. He can't sell off the entire stuff and sit on cash. In fact, as the new money comes in, he will be buying the stocks in his investment universe, no matter what the valuation. Since he will have bought stocks at high levels, he will have to stay invested for the long term to deliver returns.

So, the conclusion is that in the stock it isn't important that you stay invested for the long term. What is important is that you buy, sell, and track your portfolio as per a fixed strategy. It doesn't matter if you are invested for the long term or the short term. What is important is that you sell as per your strategy. Since the selling price of a stock may be far from the buying price, holding the stock for the long term may become necessary, yet it's not indispensable. You can as well make profits in the short to medium term.

 The writer is the author of Stock Market Investing for Employees.