How to build long-term wealth in stock markets

Start by developing a patient mindset, embracing risk and avoiding herd mentality

While it is essential to assess risk tolerance, embracing risk is equally important to reap long-term rewards. Alamy

In the fast-paced world of finance, the allure of quick gains and rapid trading often overshadows the fundamental principles of building sustainable, long-term wealth in the stock market.

While market trends, economic indicators and technological advancements are vital, one factor that often goes unnoticed but holds the key to financial success is investor behaviour.

In the UAE, where the stock market is a significant avenue for investment, understanding and mastering investor behaviour can be the difference between fleeting gains and enduring prosperity.

The UAE, with its robust economy and thriving financial sector, attracts thousands of investors seeking to capitalise on the opportunities presented by the stock market.

However, the euphoria of potential profits can lead to impulsive decision-making and irrational behaviour. Emphasising investor behaviour is essential to developing a culture of thoughtful, disciplined and informed investing.

The first tenet to building long-term wealth in the stock market is to cultivate a patient and long-term mindset.

Many investors tend to chase short-term gains, constantly buying and selling stocks, driven by market volatility and media hype.

According to a 2020 report by Dalbar, a financial services company, the typical equity investor earned 5.35 per cent less than the S&P 500 return in 2019.

And even though the fixed-income investor had their “best annual gain since 2012” of 4.62 per cent, it was still less than the 8.72 per cent benchmark index return.

The short-term approach often results in significant transaction costs and exposes investors to unnecessary risks.

Instead, a focus on long-term investing can lead to better risk management and consistent growth.

An investor’s relationship with risk is a critical aspect of their behaviour. While it is essential to assess risk tolerance, embracing risk is equally important to reap long-term rewards.

Stock market history has demonstrated that periods of market uncertainty eventually give way to growth and prosperity.

Understanding the cyclical nature of the market and staying committed to a well-diversified portfolio can help investors weather short-term storms and emerge stronger.

Educating oneself about the intricacies of the stock market is another pillar of building wealth.

Financial literacy empowers investors to make informed decisions and identify quality investments.

Unfortunately, many investors in the UAE may lack adequate financial education, leading to impulsive decisions and susceptibility to market speculation.

A 2015 World Bank report found that only 35 per cent of UAE adults possess basic financial knowledge.

This knowledge gap often leads to hasty decisions that undermine the potential for long-term wealth creation.

Initiatives aimed at enhancing financial literacy, both in schools and within the community, can contribute to a more informed investor base.

Controlling emotions during market fluctuations is perhaps the most challenging aspect of investor behaviour.

Fear and greed are potent emotions that can cloud judgment and lead to irrational decision-making.

The famous investor Warren Buffett once said: “Be fearful when others are greedy and greedy when others are fearful.”

This sage advice emphasises the importance of staying grounded during times of market exuberance or panic.

Furthermore, seeking professional advice can be invaluable in navigating the complexities of the stock market.

Financial advisers play a crucial role in guiding investors towards sound investment strategies that align with their goals and risk profiles.

Engaging in regular portfolio reviews with an adviser can help investors stay on track and make necessary adjustments to their investments as circumstances change.

Diversification is a good strategy to mitigate risks and achieve sustainable growth, with studies frequently outlining how varied portfolios consistently outperform concentrated ones, even during market downturns.

Allocating investments across diverse sectors, industries and geographic regions serves as an effective shield against vulnerabilities stemming from single-point exposure.

This prudent approach helps investors strike a balance between risk and reward, ensuring their long-term financial goals remain intact.

Finally, it is crucial to avoid herd mentality in the stock market. Following the crowd without proper research and analysis can lead to buying overvalued stocks during market peaks and selling undervalued ones during downturns.

Being contrarian and independent-minded, backed by thorough research, can provide a competitive advantage in identifying undervalued opportunities and avoiding market bubbles.

Building long-term wealth in the stock market requires more than just financial acumen and market knowledge.

Understanding and mastering investor behaviour is equally vital to achieving sustainable growth and financial security.

By fostering a patient and long-term mindset, embracing risk, enhancing financial literacy, controlling emotions, seeking professional advice, diversifying investments and avoiding herd mentality, investors in the UAE can unlock the full potential of the stock market and pave the way to lasting prosperity.

Tony Hallside is the chief executive of Dubai brokerage firm STP Partners