Equity market is the best investment to hold if you are a long term investor.
Over the short term equity mutual funds can be volatile driven by the whims and fancies of current affairs, but the disciplined investor who holds through all the noise is rewarded by some of the highest returns of all asset classes. Add the ease with which equity mutual funds can be bought and sold, either directly or through mutual funds, it is a no brainer that investors should hold them for the long run.
Ram and Shyam are having the same discussion while out for dinner.
Ram: I recently read somewhere that over a longer holding period stocks are not as risky as they are over short holding periods.
Shyam: In Indian markets?
Ram: The study was for the US markets but no reason it wouldn’t apply to the Indian market.
Shyam: Ah yeah that works in the US. The Indian markets are not the same. They are more risky and probably rigged. I wouldn’t trust my money in the Indian market, I am happy with my saving and fixed deposits.
Ram calls his friend at Kuvera – “Can you help me figure this out?”
Of course we will, it is after all our life’s goal.
So, we dig into the data. Is Shyam right that Indian markets are very different from US markets, or do stocks become a safer bet as your investment horizon increases?
We look at NIFTY data going back to Aug 1990, so a full 25 years of data. We look at 1yr, 3yr and 5yr holding periods. We also look at the data in two ways – overlapping periods and non-overlapping periods.
Let’s look at overlapping periods first:
|1 YR||3 YR||5 YR|
Over the past 25 years we have had 289 overlapping 1yr periods. How is it possible you ask? Simple, Jan-2014 to Feb-2014 is a 1yr period and so is Feb-2014 to Feb-2015. Of these 289 1yr periods, 193 had a positive return – a win percentage of 67%. Not bad you say, but notice in one of these periods you lost 74% of your investment (that must have hurt!). Also notice in one of these period you made 124% from your investment (that must have been amazing).
You can see where this is going though. The win percentage for 3yr is 82%, while it is 90% for overlapping 5yr period. Of course it is a no brainer that equity mutual funds are a much safer bet over a longer holding periods.
What about non-overlapping returns?
|1 YR||3 YR||5 YR|
The results are same, even a bit more dramatic. Of the past 5 non overlapping windows starting from Aug 1990 to Aug 2015, none have had a negative return. Of course we only have 5 data points here so we cannot infer much from this, but still the longer you can hold onto stocks the better you will do.
It’s all good in theory, but what does it mean in practice:
- You should only invest money in the stock market that you are not going to need in the next 2+ years
- Don’t get scared by conspiracy theorist like Shyam. Indian markets behave in-line with other global markets
- Financial TV and press create a sense of urgency by highlighting and magnifying every move of the stock market. Unless you are a full time day trader, stay put for the long term.
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