Short term returns versus long term returns: How to balance?

Guide To Fundamental Research | Published on 28th June 2018 | 1699

Returns on investments are for the short term and the long term. Some investments generate trading returns in a very short span of time. Some investments like Wipro and Havells can give phenomenal returns only if held for many years. The big question is how to balance between the two. You need short term returns because you cannot wait till perpetuity. You also need long term returns to create wealth. Here is how to go about balancing the two.

Treat trading and investments separately; for all practical purposes

You need both kind of returns but the important point is to treat them separately. That is why it is always suggested that you must keep them separate. When you are investing in stocks for the short term, don’t worry about how the stock will disrupt the industry in the next 20 years. That is largely immaterial. On the other, when you are looking at investing in a stock for retirement, don’t worry about short term news flows and price chart formations. Focus on the bigger picture. Does the company have a sustainable business model? Does it have the management bandwidth to handle growth? Above all, does the company maintain high standards of corporate governance that will help sustain valuations over time? Focus purely on short term returns when it comes to your short term portfolio or your trading portfolio. Here your focus is purely on how to make the best of short term and medium term opportunities in the market.

Avoid the mistake of annualizing returns; they do not work that way

Short term returns are an outcome of opportunities and therefore they are not exactly sustainable in the long term. Just because you made 10% in a single week does not mean that you can compound that 52 times in a year. If that was the case then you would be good to retire at the end of the year but that is not how it works. Annualized returns are not sustainable returns. When short term returns arise from specific opportunities, they should be treated as discrete events. When you assess long term returns then you must focus on the compounded annual growth rate (CAGR). For example, an investment of Rs.10,000 in Wipro in 1980 will be worth Rs.510 crore in 2018. If you present that as CAGR returns over 38 years, it is just about 40% returns. That is phenomenal but not too formidable when you look at it as one year returns. It is, therefore, essential to get your return perspective right.

When it comes to short term returns; focus on momentum

Short term returns arise from momentum and therefore your focus should be on momentum. Never try to be contrarian when it comes to short term returns. For the last 3 years, pharma stocks have appeared to be underpriced but they have continued to dip further. It is only since June 2018 that the momentum appears to be shifting in favour of pharma. As a short term trader looking for short term returns, you should focus on the June 2018 momentum. No point, in getting stuck in a stock by taking a contrarian view. A stock may be good at a particular price but unless the momentum is in favour of the stock or there is some specific news flow, you should not jump in the quest for short term returns.

When it comes to long term returns; focus on value and time

When it comes to long term returns, you can focus on a combination of value and time. Let us understand these two things separately. If you invest Rs.10,000 per month in an equity fund generating 15% returns per annum for 20 years, then your corpus will be worth Rs.1.51 crore in 20 years. That is substantial wealth but that is being generated by time and not by value. You generate value based wealth through direct equities and that is only possible if you interpret a story well in advance. What were the big themes in the last 20 years? IT, Pharma, Commodities, infrastructure have all been major themes in the last many years. What could be the themes going ahead? You could look at alternate energy, smart cars, artificial intelligence, big data, machine learning etc. None of these ideas will generate returns immediately; not even in the next couple of years. They may take years to even give you a semblance of returns. First, they become profitable, then they achieve scale and then come the tipping point. But to get long term returns out of value, you need to take that bet well in advance.

The moral of the story is to keep your perspective and strategy of short term returns and long term returns separate. That is the best way to draw your Chinese wall.