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Friday, 29 October 2021

When in doubt, go back to first principles


Whenever you are in doubt of what to do with your investments, or scared of the market fall, or fearful of the market topping out, just ask yourself these two questions.

1) What is my investment objective?

2) What is my investment time horizon?

I have found that if you keep asking yourself these questions during moments of doubt, there is a lot of clarity that emerges. Last few days, the markets have seen some correction and the narrative amongst people has changed. 

The last few days the rocket emojis and the “I-told-you-so” tweets & WhatsApp messages have gone missing and a large number of vocal participants, are observing a deathly silence. All this is because the fear of money is real. Prospect theory or loss-aversion theory is at play here. It is far more painful to lose money than to gain an equal sum. 

So, when you have a fall in the prices of shares you hold, there is a real fear. The fear of losing the gains. Or the fear of losing your capital. That is when the answers to the two questions help you get centered back to what you really want. If you are investing because you want to build up a retirement nest egg or if your time horizon is 10 years or more then reacting to every 10% rise and fall is meaningless.

For example, here are my answers to those questions.

1) My investment objective is to generate an absolute positive return without losing capital permanently. The additional goal is to generate 10x in 10 years by compounding at a rate of 26%. Now that may seem low with respect to how the market has turned out in the last year, but I know if I am able to do this consistently over a 10-year cycle, I will be okay.

2) I don’t need the money in the near foreseeable future, so the main objective is to be able to compound the capital for as long as possible at as high a rate as possible without taking the risk of permanent capital erosion. So, it is safe to say, that my time horizon is 20+ years.

Every time I clarify to myself these answers, the short-term urge to do “activity” reduces. It pushes me to look for stock ideas or investment strategies that align with my objective and time frame. This is also why I don’t do very short-term trading or use quant systems to do so. Because it gels with neither my objective nor my time horizon.

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