Here is the in-depth part from the book Siddhartha By Hermann Hesse:
Merchant: “If you do not have assets, how can you give?”
Siddhartha: “Everyone gives what he has. The soldier gives strength, merchant goods, teacher instruction, farmer gives rice, fisherman fish. ”
Merchant: “Very good, what can you give? What have you learned that you can give? ”
Siddhartha: “I can think, I can wait, I can fast.”
Merchant: “Is that so?”
Siddhartha: “I think so.”
When you first read these lines, they seem too short. But the more you do, the more you realize you have to be a good investor. The journey to becoming a better investor, taking the freedom to modify a little, can be divided into three stages:
1. Can you think?
The biggest threat to good decision-making is our tendency to over-weigh articles on evidence. As human beings, we have an inherent tendency to understand the world through a good cause and effect story and do not have the strings to appreciate coincidence and uncertainty.
Sometimes, this compulsive habit of connecting dots between random events greatly simplifies reality and underestimates the contribution of luck, which can lead to significant investment mistakes. Think about it, all financial bubbles are an article that has gone too far.
It is a good idea to start with the evidence, as long as possible and to look at the data in the markets. Once you identify the patterns, you can check if they make sense from a logical or behavioral perspective. You will eventually build your own evidence-based investment framework. These frameworks can be developed for different parts of the investment process – asset allocation, rebalancing, valuation, portfolio structure and entry and exit strategies. Investment frameworks reduce the chances of being distracted by articles or emotions and repeat your investment process, which can lead to better results.
Takeaway: Make decisions based on evidence-driven frameworks, not articles.
2. Can you wait?
“The stock market is a device that transfers money from patient to patient.”Ar Warren Buffett
The long-term progress of equity investment reduces our confidence in human progress and entrepreneurship. On the whole we are betting that entrepreneurs (high risk takers) will be compensated with high returns in the long run. According to Credit Suisse Global Investment Returns Yearbook 2021, It looks at equity returns over the past 121 years in countries, with equity real returns (read as returns after adjusting for inflation) 4-6% for most countries. So, it pays to be optimistic in the long run. That being said, the near term comes with its inevitable instability. Short-term, unfortunately, has the potential to turn temporary instability into permanent loss. On the other hand, enough time and patience, luxury allows us not to touch our portfolios too much, to cope with instability and to do the magic of compounding.
Takeaway: The investment favors the patient optimist.
3. Can you suffer?
While equity markets mirror revenue growth in the long run, a temporary market decline in the short term is inevitable. Sensex data from the last 40+ years show that a 10-20% temporary decline in equities is given almost every year. Occasionally, once every 3-5 years, equity markets can cross up to 30%. Although not as frequent, a 30-60% temporary decline once every 7-10 years has historically occurred. Understanding history and setting expectations around a market downturn is one thing. But living by the bear market, here the money you earned hard is dwindling every day. The real challenge is that the overall 10-20% decline seems to be the beginning of a big market crash. Only on reconsideration will it become clear what the general decline against crash is. So, while the monetary cost is clear in terms of cost, the actual cost to pay for long-term returns is not so clear — the mental anguish involved. It takes the form of uncertainty and sleepless nights. Your ability to stick to your portfolios in the long run will ultimately depend on your ability to withstand the mental anguish of temporary decline.
Takeaway: Prepare to withstand temporary market downturn.
Arun Kumar is the Head of Research and Mutual Funds at M.Funds India.