What should be your philosophy behind long term investing…

It has now been empirically proven that long term investing is what works in the case of equities. But long term investing is not just about holding on to your stocks. There are certain basic assumptions underlying long term investing that investors need to be conscious about. In fact, there are 4 basis philosophies that every long term investor needs to follow for long term investing to be successful in reality.

Avoid buying too many stocks…

That is the basic rule. You do not want to create an inordinately bulky portfolio of too many stocks. While there is no hard and fast rule about the number of stocks you should hold, your core investment portfolio should not cover more than 20 stocks. There are two distinct reasons for that. Firstly, your portfolio is something you should be able to monitor consistently and in detail. Monitoring your portfolio is all about monitoring industry trends, global macros, news, F&O data, volume shifts, advance declines, quarterly results, order book position etc. This kind of detailed monitoring is well-nigh impossible if your portfolio is too bulky.

Secondly, your core portfolio is also supposed to offer in-built diversification. According to empirical studies, 13-15 stocks in any portfolio can realize the full potential of diversification. Anything beyond that number only leads to substitution of risk and not reduction of risk. Hence, the smaller your core portfolio the better!

Avoid overtrading on your portfolio…

A long term portfolio has to be necessarily long term. Avoid getting in and out of stocks too often. Your core portfolio should change only if you perceive a serious change in the fortunes of the company due to some emerging trend that is likely to disrupt the performance of the company. When you overtrade you need to worry about the impact cost, trading costs, regulatory costs as well as taxes. As a smart long term investor you surely wan to minimize each of these costs to the extent possible since each of these small items can compound smartly over a long time frame.

Always benchmark your portfolio and evaluate its performance…

At the end of the day, the long term is nothing but a compilation of a series of short term performances. Hence it is very important that your portfolio is constantly either at par or better than the benchmark indices. If you are at par with the indices for too long, there is something wrong with your portfolio. An index fund could have done this job as effectively, then why the risk of equities? If you portfolio is consistently underperforming the index do a rigorous review of the laggards and understand why the stock price is not reflecting your fundamental beliefs. Occasional underperformance is understandable in a long term portfolio. But if your portfolio is a consistent laggard, then the alarm bells must start ringing.

Monitor and control the risk of your portfolio…

Remember, there are 2 sides to the investment game viz. return and risk. If you are earning good returns on your portfolio but the risk of your portfolio is too high, you have to change course. Always evaluate your portfolio returns on a risk-adjusted basis. Also ensure that you are constantly evaluating whether there are any disasters waiting to happen in your portfolio. For example; are there are companies in your portfolio which are highly leveraged? Are there companies whose business models are likely to be hit by disruptions? Are there companies in your portfolio which are commodity based and hence dependent on the super cycle? Are there companies in your portfolio that are losing out to competition both in terms of market share and profit margins? Each of these points is a risk highlighter and must be acted upon immediately.

An understanding of these 4 basic philosophies will help you get more value from your long term investment. It will help you actually generate wealth over the long term!

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