Is Long-term investing possible in volatile markets?

Weekend Blog 2                                                 
Shuchi.P.Nahar

"Role of behavioral finance for long-term investing".

The basic and most frequently asked question in today's scenario. 
Is long-term investing favorable in such volatile market?
Is this the right time to take entry or wait ?
Will markets fall from here or rise? 
Is short-term investing a favorable strategy to make more returns in volatile market? 

To all such basic questions to be answered, let's revise what markets probably have made us forgotten in past few months. 

"Concept of long-term investing "

If short-term investing is about capital preservation, long-term investing is about wealth creation. 

Long - term investing is about building the kind of investment portfolio that will provide you with income for later in life, and for the rest of your life. That could be retirement, or sometimes sooner.

Long-term investing doesn’t happen by accident. You need to be prepared. There are three things that can allow you to use market volatility to our advantage: 

The right structure, a long-term investment process and a behavioral checklist to allow us to remain rational when everyone else is being anything but what are the basic questions that need to be answered. 

Why you should want to invest for the long-term? 

1. Investing for the long-term allows you to take advantage of high return opportunities that others might shun. Many short-term investors might pass on a high-return investment just because the near-term outlook is weak or uncertain.
2. Being a long-term investor helps to safe guard yourself from various biases. 
3. Recency bias causes people to over-extrapolate the near-past further into the future more than the facts merit. Taking the long-term view on an investment should cause you to think about more than just what has been happening recently to arrive at a reasonable conclusion.
4. Long-term investing reduces frictional costs, such as trading expenses and tax impact.
5. Evidence shows that longer holding periods are associated with better performance.  

The answer to all the above questions might surprise you but it's simple 'Behavioral finance'. Every individual investor that reacts in the market depends only on their behavior, biases, fear and excitement. 

Here stated below are some of the basic behavior of investor which impact the most in this volatile market. 

1. Loss aversion, a behavioral economics concept, explains the pain of losing is psychologically twice as powerful as the pleasure of gaining.

You like winning and dislike losing. 
“But you dislike losing more than you like winning. Negotiations over a shrinking pie are difficult because they require an allocation of losses, whereas an expanding pie is an allocation of gains. 

Eg. If you conceded $25 an acre in cash rent as a landowner, you encounter a loss, and your tenant just made $25.”

2. Another powerful and related emotion is the endowment effect, which says people will tend to pay more to retain something they own than to obtain something new.

The Fundamentals of Good Decision-Making:

In any given day, you make endless decisions. Some will be quick, while others have long-term consequences. 
To be successful in making these business-altering decisions, craft a decision-making framework. 

Appropriate Frame: What has been decided already and what you need to decide now?

Creative Alternatives: With most decisions, you have multiple options to consider. “Outstanding decision-makers are exceptional at generating alternatives,” says Nicole Widmar, ag economist at Purdue University. “Your choice can be no better than the best of your set of alternatives.”

Relevant and Reliable Information: You can only get so much information, Meyer says, so be sure it really matters and is from unbiased sources.

Clear Values and Trade-Offs: Write down all the concerns you have about your big decision, Widmar suggests, then convert your concerns into succinct objectives.

Sound Reasoning: “We, as humans, are not designed to deal with uncertainty,” Meyer says. “We make mistakes about complex situations if we just trust our gut.” Instead, use tools such as a decision tree or scenario planning to represent what might happen.

Commitment to Action: All of this planning is for naught if you aren’t ready to take action, Meyer says. Be ready to pull the trigger.

Be Prepared to Ride Out the Ups and Downs – They’re All Part of the Game:

The risk with long-term investments is that they can fall in value at any given time. They are, of course, equity investments, and have no guarantee of principal.

But because you’re holding them for the long term, they’ll have a chance to recover. That stacks the deck in your favor. Though an investment may be down 20% over the next five years, it could double or triple in value or more in the next 10.

That’s why you have to think long-term to give yourself a chance even when it's a volatile situation to overcome the short-term dips, in favor of longer-term returns.

Weekend blog 3 will be in continuation of explaining few basic concepts of behavioral finance and biases that an investor faces throughout his investment journey.

Sources: Forbes Magazine, Good Financial CentsA, gweb Journal. 

                                            Shuchi . P. Nahar