How Long should long-term be in investing?

Most advertisements would then continue in that strain to imply that all this, and more, can be possible through long-term investments. Lucrative as they are, most people would still be confused by what constitutes a long-term investment?

Nov 19, 2017 10:11 IST India Infoline News Service

The words “long-term” invoke images of a far-off summer day, a pleasant valley, and a happy family. Most advertisements would then continue in that strain to imply that all this, and more, can be possible through long-term investments. Lucrative as they are, most people would still be confused by what constitutes a long-term investment? Investing for a marriage may take 5 years, a house 15 years and children’s college fees around 20. All these are examples of long-term investments of varying lengths.
 
The textbook definition
For taxation purposes, investments in listed stocks, and equity mutual funds are considered to be long-term if the holding period is more than one year. The holding period is defined as the period from one day after the investment has been made to one day after the investment has been encashed.
 
The ground reality
Going by the book, any investment above one year is a long-term investment. However, this definition is completely inadequate for practical purposes. Most investors would look at a long-term investment as a way to even out losses and maximise gains. In fact, long-term investments are preferred because they help us to ride out the investment cycles and achieve parity, if not profit.
 
The bottom-line
Most analysts would agree that a better definition of a long-term investment will be “An investment that has a higher probability of maximising returns over a 10-year period as compared to alternatives
 
To support this, you can draw upon some hard-hitting research on the basis of the BSE. By this,you can also tend to find a median which you can use a benchmark.
 
Before you begin, let’s take a couple of parameters into consideration-
  • Growth isn’t permanent. Disruptive companies continue to create ripples until bold becomes the new normal.
  • When things get worse, they usually don’t stop until they hit rock bottom. Rebounds are rare.
  • All data considered are for capital aggregation investments. Income generation schemes such as bonds, debentures, etc are not as influenced by time, as by interest rates.
  • FD’ and other fixed return investments are not dependent on time as well, and so are ignored.
  • Let us first define some popular investment return targets. Let’s choose the figures for 8%,10%,12%,15%, and 16.2%-the last one being average market return for last 33 years.
  • The data taken into consideration is using month-end values for Sensex from April 1979 to October 2012. 
The probability of achieving these return within a time period comes to something like this,
 

Year

Probability of achieving 8% returns

Probability of achieving 10% returns

Probability of achieving 12% returns

Probability of achieving 15% returns

Probability of achieving 16.2% returns

3

36%

58%

53%

50%

48%

4

31%

64%

59%

53%

52%

5

29%

68%

63%

56%

53%

6

23%

72%

66%

61%

59%

7

21%

76%

74%

66%

62%

8

20%

78%

74%

67%

61%

9

19%

78%

76%

68%

64%


 

 
The six-series’ mentioned in the graph are in order of the six rates of investments which have been set as targets.

This takes into consideration some high-performing and a low-performing stock. And as can be seen from our initial premise, the investments top out around the 10-year period.

Statistically speaking, a period of more than 10 years may be considered only of academic interest as a decade is really as far as you can see.

From analysis, you can notice the following facts-
  • The high-performing stocks started to peak after the 5-year mark.
  • They continued an appreciable rate of growth till they crossed the 7-year threshold.
  • After the 7-year threshold, they flattened out to a plateau.
  • The low-performing stock, on the other hand, continued to drop steadily.
  • The dip became more and more pronounced after the 7-8-year time period.
Thus, you can take an optimum measure of the 6-7-year period as the best median in which to invest for the “long-term”

In general, a 10-year cycle would help us to reach a plateau after which our stocks’ value would either fall or remain constant. Within this phase, it’s better to cash out in the 6-7-year period and invest in the new big thing. 

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