If you buy individual stocks and label them as “long-term” investments, you may need to reconsider your trading mindset. Here, we discuss the behavioural reasons why most individuals do not like to trade or why they consider trading as investments.
Trading refers to buying stocks for capital appreciation. Investing refers to buying stocks with the primary objective of earning dividend income. Most of us are traders because we buy stocks for capital appreciation.
The question then shifts to time horizon. Are you a short-term or a long-term trader? This question must be considered in the context of the core-satellite framework. The core portfolio contains your goal-based investments. Equity investments in this portfolio must preferably be in mutual funds. The satellite portfolio is a short-term trading portfolio with holding period of not more than 12 months. To put this in perspective, you will incur short-term capital gains tax on these equity holdings. This means you are actively buying and selling stocks, exchange traded funds and, perhaps, derivatives to capture short-term price changes.
Now, if you desire a certain lifestyle, more money is typically preferable, whether you are a working executive or a retiree. If trading can generate additional cashflows, then trading ought to be preferable. So, why then do individuals typically shy away from trading?
Consider this. What if you buy a stock hoping to gain in the next three days only to see the stock tank and recover after two years? You will most likely regret your decision. Also, you will be unable to cut losses. This is because losses hurt us more than gains can gives us happiness for the same magnitude of change in stock price. One way our brain tries to cope with this future regret is to shift out of the trading mindset. Calling it investment extends the time horizon and reduces the pressure to cut losses. Importantly, our brain rationalises the purchase decision in the event the stock tanks; “blue chip stock” and “fundamentally-sound company” then become the narrative.
You may argue you are truly investing for the long term. There are two ways to check if that is the case. One, are you continually looking at your “long-term investments”? And two, do you sell “investments” if they generate better-than-expected returns in the short term? If your answer is yes, you are a short-term trader, a mindset aligns with your satellite portfolio.
(The author offers training programmes for individuals to manage their personal investments)