It is a well known fact and often repeated and propogated belief that the best results from investment portfolios are achieved when they are created and operated with a long term orientation. And it is not hard to see the logic behind saying this, given that the concept of compound interest is the essence that drives investment returns. When we talk about long term investing, we tend to define in terms of investing for a certain number of years or decades. But the time period for which we invest is nothing more than a solitary aspect of long term investing.
And it is not just the investment horizon that makes long term investing effective. In its true sense, long term investing is a lot more process oriented and has a number of factors that go into it. And each of these factors must be given due emphasis in order for long term investing to be practiced effectively. Because adherence to each of these factors leads to better investment behaviour, which in turn allows us to stick with our investments for long periods of time. So today I will be speaking about each of these factors in detail, and showing how each of them tie into the broader process of long term investing.
Much of investing has to do with human emotions. But investing is effective only when we act from a place of rationality rather than emotion. Acting rationally would allow us to avoid acting impulsively based on what we think the markets and/or our investments are going to do next. This would automatically make it easier for us to stick with our investments for years and decades on end. But expecting ourselves to be completely rational about our investments at all times would be highly unrealistic. This is because it is nearly impossible for us to eliminate the influence that emotions have on our investing over long periods of time.
We must therefore learn to use our emotions to our advantage. In other words, we must be emotional about the consequences of acting impulsively with our investments, so that we completely avoid such actions. Let's take the exercise of retirement planning for instance. Instead of worrying about market crashes and corrections when accumulating assets for retirement, we must worry about the fact that not sticking to our investment plans during a crash may mean that the size of our retirement corpus may very likely shrink.
And this would effectively mean that we would not be able to enjoy the kind of lifestyle we intend to during our retirement. And this is what we must actually be emotional about, rather than the repercussions of any market crashes or corrections during the accumulation phase. Because the fear of not being able to enjoy an ideal retirement would spur us on to stick to our investment plans and maybe even invest more through a crash, thereby improving our chances of being able to enjoy a favourable outcome (the kind of lifestyle we intend to be able to lead post retirement) in the end.
Most investors also fall prey to the desire to eternally enjoy the highest returns on their portfolios. This causes them to constantly switch between investment products, looking for the ones that promise the best returns at a given point of time. But investors who do this usually end up doing the wrong thing at exactly the wrong time. In other words they end up buying when markets are high, and expected returns in the future are likely to be low. And more dangerously they tend to sell when the markets are at their lowest, leaving them at the risk of missing out on the impending market recovery.
And this makes a world of difference to the ultimate corpus that we manage to accumulate in the end. We must realise that our major goal with our investment portfolios must be to generate a neutral or positive real return after tax. In other words, our portfolios must grow at a rate which keeps pace with or beats inflation after accounting for taxes. As long as we achieve this with our portfolios and keep increasing the amount of our periodic investments at regular intervals, we should be satisfied with how our portfolios are doing. So there is simply no reason for us to chase products that promise exorbitant returns, say 15-20% per annum or more. Such returns are can be achieved, but can almost never be sustained.
Possessing the maturity to not chase performance means that we automatically run the risk of going through prolonged periods where our portfolios and investment strategies do not perform as expected, sometimes even for prolonged periods. To counter such situations, it would be advisable to put our investment plans down in writing, which would form our investment policy statement. The statement should include details on the process and reasons behind constructing our portfolios the way we have, our risk profile, reasons for including each product in our portfolios and the circumstances under which we would sell or switch products.
Periods of underperformance are inevitable regardless of the quality of our investment portfolios and strategies. And the best way for us to navigate such periods would be to ensure that we never lose sight of the big picture, that being the achievement of our major financial goals. So we must ensure that all our investment decisions are based on our investment policy statements and aligned towards helping us achieve our financial goals. And this would only be possible when all our investment decisions are made for the right reasons, free of impulsiveness and based purely on sound logic.
While a cursory look at the practice of long term investing may make it seem like the exercise is centred around a significant investment horizon, a slightly more trained eye would spot the fact that there is a clear method to it. Effective practice of long term investing requires us to display maturity, composure and pragmatism in significant and equal measure. Because it is these traits that ultimately allow us to hold on to our investments for years and decades on end. Therefore it is not the period of time for which assets are held, but adherence to a clear investment process that forms the essence of long term investing.