Letters to the Editor's Note

Summary: Why do investors treat equities like lottery tickets but hold on to cash for comfort? In this piece, Dhirendra Kumar unpacks James Tobin’s timeless idea of liquidity preference and explains how chasing control and reacting to short-term noise quietly erodes long-term returns. Readers reflect on their own investing blind spots and how to avoid falling into the same trap.

Dhirendra Kumar’s Editor’s Note, The short-term trap, published on August 23, 2025, explored why Indian investors often confuse liquidity with safety and mistake short-term trading for long-term investing. Drawing on James Tobin’s Nobel-winning insights, he explained how the illusion of control, daily price anxiety and a flawed sense of timing lead to avoidable mistakes and subpar long-term returns.

The piece resonated deeply with readers who recognised their own patterns, blind spots and psychological traps that quietly erode long-term wealth creation.

Summary

In 1958, economist James Tobin posed a deceptively simple question: Why do people hold cash when it earns no return? His answer—liquidity preference—redefined our understanding of financial behaviour. People are willing to forgo better returns in exchange for the psychological comfort of immediate access and apparent safety.

Indian retail investors fall into a similar trap. Despite equity being a proven long-term wealth creator, they often treat it like a casino. The ability to buy and sell instantly, track live prices and act on impulse creates a dangerous illusion of control. Investors mistake liquidity for safety and volatility for risk.

Tobin distinguished between real uncertainty and the artificial anxiety created by daily price movements. A farmer doesn’t check the market value of his land every day; he focuses on long-term productivity. Yet investors obsessively monitor portfolio values, making poor decisions based on short-term noise rather than long-term fundamentals.

This confusion leads to costly outcomes. Frequent trading, poor timing, taxes and transaction costs eat into returns. A portfolio compounding at 12 per cent annually becomes a 6 per cent performer once these costs are factored in. Over 20 years, Rs 10 lakh grows to Rs 96 lakh at 12 per cent, but only to Rs 32 lakh at 6 per cent.

Tobin’s insight holds true today: understand what you’re buying. Equities are fractional ownership of businesses, not lottery tickets. Real investing requires “optimal illiquidity”, accepting that long-term wealth is built by staying invested, not by constantly chasing exits. The short-term trap only closes when we stop running from patience.

What our readers say

Fabulous, Dhiren. One of the reasons people tend to sell equity earlier than they should is to meet short-term liquidity needs, which they often fail to plan properly. If short-term liquidity is rightly mapped and executed, it becomes easier to lock in capital for the long term. This is a genuine issue. - Hariharan Ananthanarayanan

A very insightful write-up on ‘liquidity preference’, which may explain some irrational behaviour. Your example of farmland was spot-on: the farmer focuses on productivity, not daily price changes. That perspective offers a clearer way to approach equity investing. Thank you. I look forward to more such pearls of wisdom. - Sunil Kothare

Your articles are of great value to serious retail investors. How much liquidity should a couple in their 80s maintain? Say Rs 5 lakh in liquid form, with the remaining Rs 20 lakh invested in stocks or mutual funds intended to be passed on to heirs. This seems to be the key takeaway after reading your article. - Seetaramaiah Nandamuru

Your article is timely and will remain relevant even 20 years from now, just as it would have been 20 years ago.

As long as “greed and fear” drive people’s stock market decisions, this will persist. But it’s not easy to overcome these traits without self-discipline, which many young professionals lack. SEBI keeps reminding us that 90 per cent lose money in F&O, yet volumes rise. Ironically, the same people who argue with their parents against keeping money in savings bank accounts or fixed deposits keep trading daily without practising what they preach.

Many technical analysts influence their behaviour. Perhaps it’s time to regulate them. I’m not sure that’s the solution, but in the absence of individual discipline, what else is? - Jayaram Sankar

Like always, your article was very informative. I’ve been investing in mutual funds since 2006. Back in 2007, my financial mentor, who followed Value Research, introduced me to your views through your TV interviews.

Since then, except for a few moments of temptation, I’ve stayed the course. I didn’t exit when funds delivered high short-term returns, and I kept averaging when returns were low. Today, I’m seeing satisfactory long-term results. - Sudhakar Kulkarni

Your note is highly appreciated. It highlights the fundamental difference between short-term and long-term investing in quality businesses aimed at wealth creation. A bit of illiquidity for a limited time can be beneficial. - H R Wason

Your article was very insightful! I can relate to everything you’ve said. These are lessons I’ve learnt through impulsive decisions over time, but hearing them articulated so clearly is very reassuring. Looking forward to your next article. - Smrithi

Really exhaustive. The quotes are excellent. One thing missing, though, is your bold advice on: a) Whether to hold or book profit/loss. b) Exit rules: loss clearly at 20 per cent, but at what point should one book profit?

Many advisories recommend various stocks, and then add disclaimers like “do your own research” or “the author holds no stake.” When the message is for the general public, there’s nothing wrong with being clear. Please consider my views; ultimately, it’s up to the individual to book profits or take risks as advised. - S Mukkunden

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This article was originally published on September 20, 2025.