In the long run, yes, he might recoup his losses. But how long will that take? One thing hecannot recover - opportunity costs. Aha, time value of money. Relate to compounding andyou can see the extent of losses actually incurred if the capital is wisely invested.Long-term investing is only successful if you relate it too value investing. Value investing, in anutshell is all about identifying deviations and discrepancy between price and value. Exploit itwisely and money starts snowballing into your pocket. How to exploit? Simple. Everyone doesthis. We buy when things are on sale. So,
buy when something is cheap relative to the valueyou are getting in return.
But the problem is this- it is difficult to define value of a company. Itis not necessary to place specific figures on this value. After all, value is a subjective term andinvesting is a form of art. Take Benjamin Graham's analogy- ‘you don’t need a scale to tell if someone is overweight’. In simple terms, profit by buying low and selling high. We all knowthis. Logical and sensible, isn’t it? Yet, the opposite is often practiced. How could someone beso whacked out of his or her mind to
buy high and sell low
? One word –
That wouldbe another topic of discussion sometime in the future.The main idea is your entry point when purchasing a share. When it is overpriced, and youbuy this company, you are expecting the market to go higher (recall tech bubble in at thebeginning of the century). But heated markets will cool down or worse, things will start tocollapse. So, your downside is way greater than your upside. There is still upside, but withminimum probability. Where as if you bought it at a lower price, or a discounted price to its fair value, your downside is lower since the company either has the potential to unlock its value or the market will gradually recognise and reward it with higher valuation. To make yourself feelbetter when things fall, or worse, collapse, you will start saying to yourself you are buying for the long-term.Take this for example. Your share value falls by 50% from $100 to $50. In order to break-even or coming back to your original position, you need to gain 100% of the current value of $50. Assuming the general market grows by 15% annually after this downturn (this is a veryoptimistic projection), you need 5 years to recoup your losses assuming you do not cost-average your losses. 5 years past and you only broke-even. So much for long-term investing. Again, relate this to compounding. Assuming after so many years you could not recover your loss of $50. Is your actual loss limited to $50? Not really. Factor in the opportunity costs of having the initial capital invested in bank. At a given interest rate of 3% per annum (again, thisrate is extremely high given today’s condition. This article was written sometime ago beforethe market was on its knee) compounded for 5 years, you will get $115.93 in Year 5. So there