Stock Shastra #14: To enjoy the fruits of stock investing, be like a fruit orchard owner
After reading the headline, you are probably wondering ‘why is stock investing, so much like owning a fruit orchard? For this, let’s peek into the life of a fruit orchard owner – He takes pains to decide which fruit to plant, prepares the soil accordingly and takes all the trouble required to plant the tree the right way and at the right time. Once the fruit owner has planted the tree, he waits patiently for the tree to bear fruit. He depends on the health of the tree to grow and bear fruit. He knows that once the tree bears fruit, it will continue to do so for a long time and hence, he can reap the benefits for many years to come. It may happen that in one season the tree doesn’t bear fruit, but as long as the health of the tree is good, he is confident that it will bear fruit in the next season.
Similarly before investing, an investor needs to take all the efforts to find and check if the company has the ability to grow in future and be a winner. Your return on the investment will depend on the growth & strength of the company in the long-term. Just as the case with the tree not bearing fruit for a particular time, you need not give importance to the short-term ups and downs of the company as long as you are confident that it is fundamentally strong
Consider this: The Singapore variety of coconut takes around 3 years to bear coconuts the first time and then it continues to give coconuts for more than 30 years. If you are impressed by this, what’s more impressive is the Indian coconut which takes around 7 years to bear fruit and henceforth gives coconuts for 70 years.
Unlike, the fruit orchard owner way of investing, there can be other ways of investing too:
- The ‘Fisherman’ way who goes everyday to catch fish and depends on luck and chance for it. Wondering whose way of investing does this match – A day-trader’s
- The other way is of a ‘Vegetable Farmer’ who has to put in a lot of efforts to get his vegetable to grow periodically. This matches a short-term perspective with a 30/60/90 day horizon.
But what are the problems with the above two ways of investing? One depends on luck and the other depends on tending to the investment continuously to bear some result. Both have short-term perspectives and require your continuous engagement. But here’s the catch – It has been proved that the probability of earning returns in the short-term is more like tossing a coin with 50-50 chance of getting the positive result. This is more like a computer picking up a stock for you.
As seen in the above graph, the probability of a positive gain and return increases with the time-horizon. The probability of a positive return is around 50 % for a period of 1 day to 1 month, and increases to 72% for a year and reaches a point of certainty almost 100% for a period of 10 years. Hence, the risk over a long-term period is almost minimal. This is because in the long-term usually the market price corrects itself to a rational level based on the company’s capacity to grow and earn; unlike the short-term where your returns is based more on market behavior. Also, when you have a short-term perspective, pushing in and pulling out money increases your transaction costs and your tax on capital gains. These extra costs are immediately wiped out once you invest with a long-term perspective. Hence all of this, ensures better returns with minimal risk over a long-term (10 year) horizon.
In spite of knowing this, why don’t we invest with a long-term perspective?
Here is where most of us get trapped. The zest to earn fast money is almost ingrained in all of us; the desire of which leads to being in action all the time. Investors are always itching to take some action on the stock. If analyzed it should be bought regardless of the price, and when bought you will be glued to your favorite channel or website every day to track its price movement.
And if the price has dropped and your stock is in losses you tend to take further action on it. Why? It has been proved people regret losses 2-2.5 times more than similar-sized gains. Also, many investors may invest with a long-term perspective, but evaluating the losses and gains every few days, makes is again the sign of a short-term perspective. This desire to be in action all the time leads to buying and selling at the wrong times; leading to usually negative or meager returns.
Many of you must be ardent followers of football. What’s the most interesting part of the whole game? Most of you will agree that penalty shots really keep glued to the screen. Have you realized that many times a goalkeeper misses a shot hit in the centre because he dived to the right/left. A research shows that goalkeepers tend to dive to the left or the right as much as 94 out of 100 times. In reality if they had stayed in the centre they would have saved more goals as 60% of the goals are hit in the centre. But a goalkeeper wouldn’t look good standing still and conceding a goal to your left or right, would he?
Concluding, you need to avoid checking your portfolio often and suppress the desire to be in action all the time; because this will result in a short-term perspective. While investing in stocks, always keep a long-term perspective, as this will give you the best returns with minimal risk.