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What means long term in investing?

2012 May 16

When I talk to non-professional investors, I often get surprised on their interpretation of ‘long-term investment’. Of course, everyone wants to enjoy their lives and to do it fast, while not many are ready to wait for a long period just to earn some interest or dividend. It is completely natural and can be justified. 


However, investing is a long term process, and there can’t be done anything about it to make a change. It is how it is, and every investor has to be ready for it. If he/she is not, then better to do anything else with the money rather than investing. I am sure, you have some ideas how to spend those money. If you are not, then you are born to be investor and all you have is the patience. 


Let’s get back now to the ‘long-term’ definition. Those investors who deeply surprised me, they were thinking that if they are investing for 6 months, it is a long term investment. And such understanding is completely wrong because 6 months in investing is very short period. Of course, I’m not talking about speculating or accumulating the money in bank’s account but I’m talking about normal investment process when stocks are included in investment portfolio


So what is long-term then? Let me put it this way. Normal investing according to me is based on the value of the investment. (Those investors who make their decisions using technical analysis and other mystical tools I do not treat as normal ones). So if investment result depends on the value of investment, there might be two elements that might move the results:  change in the value of investment or change in gap between the price of investment and the value of it. 


The gap between the price and the value of stock or other investment depends on many factors and the understanding of the value. It is normal that investors see the value differently and those who are more accurate, wins. When markets are inefficient or when investors are ruled by fear, the gap may be very wide. And investor should not close the deal as long as he believes that value of his stock is higher than the price. If investor is right, and stock price is higher than its target value, it may takes years until others will also understand the value in the same way and stock price will increase. 


Every investor that invests in stocks should be ready to wait for the return for years until the stock will be ready to sell. Yet, another important factor is that markets are cyclical. When you are investing in stocks, you cannot know if this cycle will go up and how long it will last. Some markets do not recover for a very long period (for example, Japan case) and every investor has to be ready for that. It would mean that investment period should include at least one full economical cycle. Such cycles are of different length in practice, but if the portfolio of investor is well diversified, then it is very probable that the cycle won’t last longer than 10 years globally. 


As for a resume, I would say ‘long-term investment’ should be oriented for a period of not shorter than 10 years. While investing for 2-10 years period should be called as ‘mid-term’, while any investments that are made in stocks or other capital markets for a shorter period than 2 years should be treated as speculation. 


Read next article: European Dividend Stocks

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