The only term you need to know is ‘long-term’
Reason #1: Market volatility can erode your capital in the short-term
Traditional economic theory assumes that all investors are rational and that they always make rational investment decisions. However, that is far from reality. In the short-term, there are a host of factors that impact stock prices. Company specific developments that only have near term impact, market sentiments, investor greed and fear, and transitory events. Due to these, stock prices tend to be more volatile in the short-term. Now, as a human being you can’t always be rational. There will be times when these transitory factors will impact you and influence you to make investment decisions that might not be optimal. Class example is of selling in fear when the markets are falling and not exiting an investment when an opportunity presents itself. However, what happens in the long-term is that the true value of the investment eventually emerges. Further, all these short-term movements also get smoothened out. So, when you become a long-term investor, you tend to ignore short-term movements and stay focused on realising the true value of your investment. As the legendary Warren Buffet put it, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” All you need to do is sow the seeds of investment and then wait patiently for the tree to grow.
Reason #2: Compounding can exponentially grow your wealth
Compounding is a beautiful mathematical concept that can make your money work for you in such a way that over a period of time, you witness exponential growth. The compounding process ensures that when you invest money, both the principal invested and the returns generated, earn interest. Over a period of time, as the interest earned keeps increasing so do the returns generated.
Let’s explain this better with an example.
Assume you invest Rs. 1000 at 10% per annum.
Amount at the beginning of the year
Total interest earned
Amount at the end of the year
10% x 1000
1000 + 100 = 1100
10% x 1000 + 10% x 100
1100 + 110 = 1210
10% x 1000 + 10% x 210
1210 + 121 = 1331
10% x 1000 + 10% x 331
1331 + 133.1 =
10% x 1000 + 10% x 464
1464 + 146.4 = 1610
The longer you stay invested, the higher the probability of witnessing exponential growth.
So, if you really want to benefit from the wealth creation potential of equities, then it is time to remove the myopic lens and think long-term.
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