Why Your Equity Investments Should Not be Based on Short Term Market Predictions?

One of the standard question you will counter at any meeting with investors is “Where do you see the Sensex after 1 year”. You obviously cannot say that you don’t have any idea because that would put off the investor. So you end up giving an ambiguous answer. Even as the investor walks away satisfied, you realize that the question reeks of short-termism.

When we talk of equity investing, we are referring to the very long term by default. What do we mean by long term? You must not expect great returns even on quality stocks in less than 7-8 years. The beauty of equity investing is that over the longer time frame, it not only evens out volatility but earns enough to compensate for your waiting period. Here is why, in an era of 24X7 news channels and social media, you must avoid the lure of short term predictions.

a) Wealth gets created over the long term

Had you invested Rs.10,000 in Wipro in 1980, it would be worth Rs.550 crore today. Alternatively, if you had invested Rs.1 lakh in Havells in 1997, it would be worth Rs.32 crore today. Of course, the list can go on but the moral of the story is that stock investments only create wealth in the long run. There are 3 reasons for the same. Firstly, companies generate value when they make sustainable cash flows and that takes time. Secondly, any stock takes 8-10 years to perfect its business model and achieve economies of scale. Lastly, short term predictions only focus on churning your money adding to your transaction costs and tax liability. You need to commit to equities for the long term to create wealth.

b) Short term is ruled by bursts of volatility

Volatility maybe good for a scalper or an options trader; but volatility is not great news for an investor. Had you invested in Bajaj Finance at Rs.3000 in September 2018, you would have seen the value deplete by over 30% in the next 6 months. Maruti lost over 50% in the last one year. These are not mid-caps, but sector stalwarts that generated humongous wealth over the last 15-20 years. Judging these stocks by their 1 year performance would mean you lose out on the real long term value creators. In the short term, market prices tend to be vulnerable to news flows.

c) There is too much noise in the short term

In today’s markets, the information and analysis overload simply cannot be missed. With round the clock channels and a seamless social media, it is very easy to create noise in the market. Noise refers to the information flows that create spikes in volatility. More often, the noise is due to lack of understanding of the bigger picture. When you get focused on noise, you tend to lose focus on value. For long term investing, it is essential to divorce your mind from the noise and take a clear fundamental view of the company. After all, behind every stock there is a company and that is what you need to focus on.

d) Outperformance and underperformance can be deceptive

One of the best ways of assessing equity investment performance is to benchmark with an index (either the Nifty or the Sensex). That is where the short term comparison can be quite misleading. For example, if you evaluate auto stocks over the last 1 year then the performance would be largely disappointing. However, if you were to look at a longer term perspective, then returns would still be quite flattering. Short term outperformance can be misleading as the short term performance of a stock may cloud the long term problems underlying a company.

e) Investments that gels with your long term goals

Why do we invest in long term asset classes like equities and equity mutual funds? The idea is to synchronize with your long term goals like retirement planning, corpus building, children’s education etc. In such cases, you need long term equity investments that can beat volatility over the long term, consistently create value and be reliable due to its fundamentally sound footing. You cannot plan your retirement with dubious stocks that may outperform in the short term but can be extremely risky in the long term. A very myopic approach to equities can actually end up compromising your long term goals.

The moral of the story is that even quality stocks need time to perform and translate this performance into returns. That is why; long term approach to equities works best!