Defining Long Term Equities

‘Equities are for the long term’, ‘Long term prospects looks bright in equities’, ’Don’t worry if the Sensex is declining, stay invested for long term and you could get your return’. These are few words used by almost everyone with whom we have a conversation on investments in stock markets. But as an investor, the biggest question for all is - what is ‘long’ term and how far it is from today?

Over the years I have interacted with many investors having their own definition of long term, for some long term is lifelong or decades and for few it is 6 months to 1 year. It is not that some of them are correct and some are wrong, they all have different needs and different risk appetite. I do not plan to discuss Financial Planning here, I would like to share some data and then let you decide on your own – How long is long term when it comes to investment in Equities.

There is no doubt that every investor should invest a part of their portfolio in Equities, because it is one asset class that has the potential to give good return along with liquidity in the long term.

Going back to 1979 when country’s first benchmark BSE Sensex started and was based at 100 and as on 30 September 2014 BSE Sensex was at 26,630.51. It has been a journey spanning 35 years. Let us look at how BSE Sensex have performed through these years and what return one would have received over a cycle or period of time.

I have worked upon rolling period / cycle for 1, 3, 5, 7, 10, 12 and 15 years. To understand Rolling Period / Cycle let us take an example, an investor invested in S&P BSE Sensex on 1-Oct-2004 and continued to be invested as on 30-Sep-2014, this period is 10 years Rolling Period / Cycle. The Compounded Annual Growth Rate (CAGR) on his investment is 16.90% p.a. for the 10 year period.

Let us have a look at the below table:

Data of S&P BSE Sensex from 28-Sep-1979 to 30-Sep-2014

Source: Sensex values from Bloomberg
Past performance may or may not sustain in future.

Source: Sensex values from Bloomberg

Please note that the above chart is to explain / understand how the equities have performed in the long term. The table shall not be considered constructed to ensure minimum / indicative / guaranteed returns or safety from equities. Past performance may or may not sustain in future.

From the above table and graph, few observations which will help us in understanding the nature of equity investments.

• Out of 35 Rolling periods for 1 year, there are 9 occasions where the return on investment is negative i.e. an average 1 out of 4 rolling period have a probability of negative return. This sounds like a risky proposition.

• In 3, 5, 7 and 10 years rolling period the number of negative return reduces to 4, 2, 2 and 1 respectively. Risk reduces as numbers of years increase.

• There is no negative return if the investor would have stayed invested for more than 10 years. Risk almost negated.

Another important point to look at is the situations where stock market does not do well. The Bear phase of stock market and how the investment did in such scenario. The below table has data for 9 occasions when BSE Sensex gave negative return over 1 year rolling period.

Source: Sensex values from Bloomberg

Please note that the above table is to explain / understand how the equities have performed in the long term. The table shall not be considered constructed to ensure minimum / indicative / guaranteed returns or safety from equities. Past performance may or may not sustain in future.

The above data shows that when investors return are negative during a rolling period of 1 year, investors who were invested for more than 7 years have managed to get reasonable return except for the year 2001.

A word of caution, there are lot of companies listed on stock market. We must understand various parameters associated with the business of these companies and then pick the right set of companies. Investing in good companies can result in good return and peace of mind, investing in wrong companies could leave a big impact on the pocket and probably a dislike for equities throughout life or through generations.

Hence, while investing in equities either directly on your own or through Equity diversified mutual funds, ensure that you make right choices, speak to your financial advisor, think long term and enjoy the benefits of one of the most productive asset class in the world.

Above article is authored by Quantum.

View All