Investing in the stock market is becoming luring for people. Many of us think of it as a tool to get quickly rich. What investors lack is discipline and patience to stay in the market for the long term.
To stay invested for a longer tenure, one needs to understand the right way of observing the market.
The market is no easy play, as not everything you see may be correct and vice versa.
The correct way to look at the market returns:
We usually look at average historical returns as a primary activity before investing. This way of finding better avenues to invest is not totally correct. It doesn’t consider every factor about the returns, thus may give an incorrect picture.
Looking only at the average market returns at a particular point in time may give a biased result. You may end up having too high or too low expectations. Over a period of time, stock prices show volatility.
One of the ways to look at the market returns with accuracy is ‘Rolling returns’. Rolling returns guide investors on the range of returns that are expected, showing the highest return, lowest return, and average return for a given time period.
Let’s understand the concept of Rolling returns by the following example.
Looking at the image below, if you consider the period of one year beginning from January 2016 to December 2016, the market gave a return of 12% in the year.
Instead, an investor started investing in February 2016, his return was 20% at the end of one year in January 2017. Someone lucky might have started investing in March 2016 and completed one year in February 2017 with a return of 25%.
Thus, these different one-year periods show the series of possible market returns in a year.
Looking only at the average returns may prove to be misguiding for the investors. The whole picture may differ. For example, the Nifty 50 gave a 14% average market return for the last five years.
This does not give the whole picture of an investor who has 5 years investment horizon. Another noteworthy thing is the highest return for five years was 75% and the lowest return for the five years was 2%.
Apparently, the time period of above five years has the lowest return in a positive number. Therefore, it is evident that the larger the time frame, the higher the possibility of positive returns and a low risk of losing capital.
Defining tenure can be a subjective term for investing, but one can follow this general definition to understand the difference.
What do Long-term investing and Short-term investing mean?
Generally, Long-term investing means staying invested in any financial asset for more than one year. On the other hand, short-term investing means staying invested in the same financial asset for a period of lesser than one year. Though, these definitions are only correct from a taxation perspective.
Individual definitions of long term and short term may differ for all of us. For some, it may be just a year, but for others, the long term can be 10 years.
Looking at the above chart, we can see that there are almost 100% chance of positive returns if one stays invested for at least 5 years. Hence when thinking about investing for long term, one should have minimum time horizon of 5 years, though more the better.
Why Long-term investing is a better option?
1. Less time-consuming
One of the major benefits of investing for the long-term is you do not need to constantly monitor your investment. In short-term investing, you constantly need to monitor the price movements. This requires more time and huge effort.
On the other hand, long-term investing gives you a hassle-free experience. Once you selected the fundamentally strong stocks, you can choose to stay relaxed. You just need to periodically check their performance.
2. Higher returns due to compounding
Compounding, which was called the ‘eighth wonder of the world’ by Albert Einstein, has phenomenal power. This element enters into the game of long-term investing if dividends and stock returns over time are reinvested. The larger the investment horizon, the higher the power of compounding and vice versa.
Suppose Harshit and Ronak, and Meet invest Rs. 5,00,000 on the same day in the same stock and earn the same interest of 10%. All of them decided to stay invested for 12 years. Harshit thought of withdrawing the interest every year, whereas Ronak and Meet chose to reinvest the interest.
Harshit who chose to withdraw the interest every year would receive Rs. 11,00,000 at the end of 12 years. Whereas, Ronak and Meet would receive Rs. 15, 69,214 at the end of 12 years.
Now, Meet wants to stay invested for further 3 years and wants to keep reinvesting the interest. At the end of his 15 years of investment, he would receive Rs. 20,88,624 even with the same rate of interest. This shows the real power of compounding.
3. No burden of timing the market
Short-term investing requires a trader to time the market. The practice of timing the market can make huge money, on the one hand, the investors may end up losing huge on the other due to wrong anticipation. Due to the fact that the ‘Future is uncertain’, predicting the market exactly is impossible.
If you are a long-term investor, you can be free of the stress of predicting future price movements and taking entry and exit decisions frequently.
4. Negligible impact of short-term fluctuations
Price fluctuation is inherently in the nature of the stock market. This tends to bring in human emotions, and investors may end up taking wrong decisions looking at such fluctuations. The recent Russia vs Ukraine crisis is one example. ‘Volatility’, which is a big part of the picture of short-term investing, is a very small part of long-term investing. The large picture of long-term investing allows investors to avoid such short-term fluctuations.
Points to take care of when invested for the long term
Following are the points you should take care of while invested for the long term.
• Keeping yourself updated about the news is not bad but taking entry or exiting from funds on such short-term news can impact your long-term investment.
• Do not expect to get your return doubled in a very short span of a month or even a year.
• Do not think of beating the benchmarks, in terms of return, all the time. If you are investing with discipline and consistency, beating the benchmark would be of little account in the long term.
• Do not make any decision with emotional bias or intuition. Rely more on data than anything else.
To sum up, long-term investing is a key to unlocking huge potential returns. Though long-term investing is the plant that you do not need to water daily but taking care of it periodically is important.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)