So, a lot of time when we talk about being invested in an investment instrument for a long period of time, you know, it sounds very boring because investors, they all want to make a quick buck and just come out of the investment, use the money and then maybe come back to it again. But then, long-term investment, it needs patience, it needs discipline and it is also boring. How would you like to explain this concept, not only for investors to understand the kind of profit or rewarding benefit that they would have, but how being invested for a long-term investment duration in any investment instrument, also makes you a very disciplined investor, thereby leading you on your path of financial freedom?
Thanks for bringing this topic because it is an extremely important topic, very close to my heart. So, Carl Richards, a famous author, who writes in the New York Times and has published many books on investment, says that long-term investing is like watching grass grow.And it came to mind because you, in your opening, you said that, it is very boring a couple of times and actually it is very boring just sitting and watching grass grow.
So that is the example that sprung to mind and that is really what long-term investing is all about. And the problem really is that as an investor, you need to understand who you are, you need to know thyself.
The stock market for example is made up of investors and traders and the mistake that people make is when traders try to become investors and investors try to become traders. And that is really where we make mistakes. And we need to be very clear as to what portion of a portfolio is going to be an investor because an investor essentially is viewing; for example, if you are investing in stocks you are viewing buying a business and you are owning a piece of business and you are actually doing your wealth in accordance with an owner of that piece of business.
And really, that is the view, that there is something inherent of value in what you are investing in and that value is increasing on a regular basis. While traders are looking more at chasing momentum, seeing that where is the smart money coming in, where is all the trades happening, where is the big money coming in, what are the different reasons why money is chasing a particular stock or exiting a particular stock. So, really the long-term investing, so much has been said about the power of compounding but it also, and let me just underscore the power of compounding here because human beings are not able to think in exponential terms. Linear thinking comes very naturally to us.
So for us to be able to, we need to be re-explained the power of compounding with different examples continually to kind of make sure that we remember it. And the other one, obviously is risk that you end up reducing risk the longer you stay invested, especially for example in the stock market because it is like looking at a graph of the stock price movement and you will see the graph going up and down very drastically. And as you zoom out of that graph, when you look at the longer time period, maybe you do not look at a week or a month, instead you start looking at five years, 10 years, 20 years that is when you will see that those zigzags seem to disappear and the line becomes almost straight and that is really what happens.
The smoothing effect of larger time horizons ends up reducing the volatility of investments and reducing the risk that you take as an investor. So these are the two key reasons why long-term investing is beneficial and why you should seriously consider a portion of your portfolio to be allocated to this.
I also want you to explain to our viewers the technical aspect of it. If you are invested, let us say, in a mutual fund, which is usually recommended for a goal that you have lined up, a very important life goal of yours. How does it technically benefit you to stay disciplined in your investment for a longer period of time?
If you are not disciplined, what does that mean? What is the behaviour you are displaying when you are not disciplined? It means that you are withdrawing the money before you achieve your goal. You are trying to time the market where you’ are trying to put in investments at perceived bottoms and you start anticipating what the market will do. And in that thought process or in that mindset, then an investor is trying to act like a trader. And that is really where you make a mistake because one needs to understand that you cannot really time the market.
And study upon study shows that that investment return is higher than investor return. It is because of these behaviours where you try to time the market. So when the market is at an all time high and you are second guessing, saying that it cannot go any higher than this and you withdraw your investments, then it becomes too late. We saw so many clients take that decision during Covid when the market fell by 40% in a couple of weeks and a lot of clients withdrew their money saying that this is a free fall and will go even further.
So they stepped away from the disciplined approach because the market has seen all ups and downs over the last 20, 30 years, because you name it, how many wars, how many global financial crisis, you can name whatever you want.
And after that because the market bounced back so quickly, a lot of investors were left with cash saying that, okay, now it is too expensive maybe we will wait for it to correct and then that time never came back. And the people who stayed invested, who stayed disciplined, stayed true to their course, they were able to capture that upswing as well. So really what you need to understand is that when markets and especially if you start tracking bull markets, you start tracking where the returns are coming from.
Now, gradually, you will see that more and more returns are being generated in shorter periods of time, which means that earlier bull runs and the return would generate over six, seven months of upward momentum now it happens in spurts of two, three weeks. And really, it is a few trading sessions where majority of the returns are being generated. And this is, you can see for the last four, five years in the stock market, that is what seems to be happening. And if you want to capture those two, three weeks, you have to stay invested. So each week is important because you never know which is that one week where you will be able to capture that upside.
So specifically talking about mutual funds, is this the only investment instrument where you should be parked in for long term or this is the instrument where if you want to reap the benefits, long term is the way to go for it?
So, you know, a mutual fund by its very design is a long term wealth creation tool and that is why it is synonymous with long term investing. You are essentially relying on someone who is building a portfolio of stocks and rebalancing that portfolio of stocks from time to time in equity mutual fund. Similarly, on the debt side, on the debt mutual fund, if they are, let us say, a accrual fund, they are simply holding a basket of fixed income securities with minor modifications there till maturity and replenishing that basket continually. But you can look at, for example, other investments also as long term. So there are insurance linked products. They are fixed deposits. There are so many, I mean, recurring deposits. So, you know, even traditional options like that have been essentially LIC products, from 20 years back, real estate investment.
There are so many other investments that can be viewed and treated as a long term investment. Mutual funds obviously are now the most popular and well advertised and recognized as a long term wealth creation tool.