Wednesday, 30 October 2013

Maximise returns: 5 things that long-term investors do differently

A frequent question asked by investors is: how long is long term? As a research student working with annual returns, I would have answered the question with the results of my number-crunching exercises. Having witnessed several market cycles since then, I would now say that long term is infinite. A long-term investor would want to hold on to his investments forever.

It's more about attitude than number. When we choose a career, we do not invest in ourselves hoping to 'cash out' some time soon in order to pursue something else. Even those who switch careers successfully give their all to what they do. They invest in their careers as if it was all that they would do for a long, long time. Long-term investing requires this attitude. What would we do differently if we were long-term investors?

First, long-term investors take the time to understand what they are doing and why. Those who buy an IPO because they have made money mostly by buying IPOs earlier are not long-term investors. They are only replicating a lazy tactic to make money. If there is no method to selecting investments, they are not longterm investors. Such people want to know all about the investments they are buying. They spend time and effort on learning, research and analysis. Many take offence when I tell them they have bought a stock or a mutual fund on a whim or a tip. I then ask them to list their investments and tell me why they bought those.

By the time we reach the fourth item, the truth is out. Most investors buy without adequate groundwork and think that if they hold it for a long time, they are long-term investors. This is not true.

Second, long-term investors understand that returns will be reasonable; they do not expect miracles. If they manage a multi-bagger stock or a winning fund, they know that in the process of acquiring this star, they have also bought a few not-so good investments.

They may have exercised the same diligence in selecting the latter. Despite this, all their investments will not rise and shine. Long-term investors know that there is no formula for picking winners, that they will be fine on an average, and hence, keep their return expectations normal. If they earn a return of 15-16% in the long term, they have beateninflation, earned more than the bank deposit rates, and built reasonable wealth. Getting to this number involves a few losing picks and a few multi-baggers, and longterm investors know this is the process to build wealth. They do not insist that each investment earn a high rate of return every year.

Third, long-term investors accept economic cycles as an inevitable reality. They know that a growing economy will create a large number of enthusiasts, who will set up, expand, grow and showcase their businesses as investment opportunities. They know that a cycle of high demand will take prices up and every business could make profits. However, they also figure that this optimism would become irrational when poor quality businesses get money, and when investors are greedy to grab unknown stocks. When the cats and dogs, as penny stocks are called, tend to make headlines, the long-term investors know the market has overdone its enthusiasm.

They use this euphoria to get out of the mediocre stocks. During times of desperation, when the cycle is at a low, the long-term investors see opportunity. When even the good stocks are shunned, and when businesses have turned around their balance sheets, they step in to take advantage of the cycle. They know that they have to be in tune with the cycles and time their investments. Fourth, long-term investors admit their mistakes and make corrections.

Since their investment logic is pre-stated and they know why they have bought a particular product, they are willing to put their investments to test. They have learned to identify the critical factors that impact their investments. If they see the leverage increasing even as margins are falling, they know that their company needs a high-revenue growth to stay attractive.

If they find that asset acquisition is not translating into revenue, they know that without the pricing power that brings a higher margin, their stock will be under stress. They can track their investment, anticipating a growth path they had envisaged. They then differentiate blips from course correction and act accordingly. To get long-term investors to sell, it is important that the case they made while buying the investment, fails.

Fifth, they do not see investing as easy and quick. They are more fundamentally grounded. They also know that they are not alone in the market and that several other players express their views on a stock. So, they accept gyrating prices as a market reality, but do not see it as an opportunity to make quick money. They do not buy into tricks and thumb rules. They see investing as a strategic decision, where they have to choose, decide the proportion to invest in each pick, monitor and manage how the portfolio is doing, and take action when the big picture seems to be changing. This is why finding long-term investors is tough. Those who bought anything offered in 2007-8, are angry and desperate on finding that their investment has not provided any return in the past six years. They ask how long they may have to wait. If they did not buy with the intent to hold on forever, they were short-term investors. Time will not make their investment decisions right.

Source - The Economics Times

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