How long is 'long-term' investment?
The average long-term equity return in India is 16.2%"
"The government is taking steps to encourage long-term investing"
"You should create a long-term portfolio of blue-chip stocks"
Every article you read and investment program you watch on TV will tell you that you should be investing for the long-term. There are two reasons for this:
1. Wealth creation takes time
2. Equity returns are not fixed and you must be prepared to stay invested for a few years to get close to average return
But how long is that 'long term'? How many years?
You will get a different answer depending on whom you ask. For the purpose of capital gains tax, long-term is 1 year. But for most investors long-term means anything between 3 and 10 years. Most investment advisors choose not to define this term because they can hide behind the ambiguity when the investor's portfolio fails to perform.
We decided to find the answer. In our usual way, we went about the task by analysing data and our conclusion is; hold your breath, 7 years!
How did we get to this magic number? We looked at the BSE Sensex data for the last 33 years and calculated the probability of an investor achieving a target return irrespective of the time when the investment was made. The targets we defined were 8%(average rate of inflation), 10%, 12%, 15% and 16.2% - the last being the 33 year average market return.
For investment duration of 7 years, you have a high probability (67%) of achieving a return greater than 15% and even higher probability (75%) of achieving a return greater than 12%. At the same time, there is a low (but real) probability (21%) of getting a return less than 8%.
The accompanying chart also serves as a useful guide to understanding the risks associated with equity investing. The probability of poor returns never completely goes away but increasing your holding period improves the probability of superior returns.
A note for our mathematically inclined readers: The analysis was done using month end values of the Sensex starting April 1979 to October 2012. For the 84 month investment duration we obtained a mean return of 17.7% with a standard deviation of 10.3%. For 72 months duration the mean is 17.9% with standard deviation of 11.5%.
The author is CEO of scripbox.com. The views and ideas expressed in this article are his personal opinion and do not reflect the views of scripbox.com or moneycontrol.com.