Being dead may be a good investing strategy. Some years ago, Fidelity Investments conducted a study in the US to find out what kind of investor accounts had the best returns. It turned out that the highest returns were from investors who had completely forgotten about their investments for years, even decades. Not just that, they also discovered that a good proportion of these investors had died a long time ago. So it may be safe to conclude that as far as managing your investment portfolio goes, the most profitable strategy may be to do exactly what a dead person would do—which is nothing.
There are similar stories in India too. A few days ago, on an investor call-in show aired on a stock market channel, someone had a query that reminded me of the Fidelity study. The caller, who seemed unfamiliar with the equity markets, said that some 25 years ago, an uncle of his had bought 20,000 shares of MRF. He wanted to know if the shares would be worth anything. If the story is true, the shares might be worth around Rs 130 crore today. Even if the number of shares is exaggerated, the fact remains that an investor in this company would have multiplied their investment by close to 200 times over the years. I’m a member of a social media group that is ostensibly dedicated to long-term investing. However, there seems to be a struggle within the group about what long term means. Opinions vary widely, ranging from a high of six to seven months down to anything that is not day-trading.
So what exactly is a long-term investment? How long is long-term? Well, there’s one official answer from the revenue department of the Government of India. For the purpose of calculating your tax liability, investments in listed stocks and equity mutual funds are considered long term if the holding period is one year. For other investments, the limit is three years. This may be the law for taxation, but it doesn’t apply when it comes to investing. One year is a very short period for equity.
So what period can be called long term? To get the answer, let’s get back to the basics and ask the fundamental question: Why should equity investing be done only for the long term? The answer, of course, is volatility. Currently, the five-year return of the BSE Sensex is 12.77 % per annum, or 79% cumulative. However, the five individual one-year periods yielded 9%, 41.8%, -8.9%, 16.2% and 9.5% respectively. This is a powerful argument in favour of equity investments being long term. The returns are great, but the variability is high. During any particular short period, you could face poor returns, or even losses. These are compensated for only by the occasional great phase.
Let’s look at it from a different perspective. The equity markets move in cycles, and often, it takes five to seven years to go through a full cycle of a sharp rise, followed by a decline and stagnation. To get the right level of returns, we need to keep investing throughout the whole cycle. That won’t happen in a year or even two.
There’s yet another way of looking at it. This comes complete with evidence from a study that Value Research conducted earlier this year. We found that on an average, if you invest through an systematic investment plan over four years, your risk of making a loss is negligible. For a typical fund with a multi-decade history, over all possible one year periods, the maximum returns are 160% and the minimum -57%. Over two years, this becomes 82% and -34%. Over three years, 63% and -18% and over five, 54% and 4%. This means there’s never any loss. Over 10 years, the maximum is 30% and the minimum 13%. These are all annualised figures. The trade-off is clear—the shorter the period, the higher the potential gain, but the worse the possible risk.
This evidence squarely puts long-term at five years and above.
So there’s your answer: in equity investment, ‘long-term’ is not a vague hand-waving term which can be defined however someone wishes. It’s five years and above, and that is that.
The author is the Founder and CEO of Value Research
Disclaimer: The facts and opinions written in this column are those of the author and do not reflect the views of economictimes.com.