Posted On Wednesday, Mar 18, 2015
The "Rule of Three" might strike a chord with professionals from more backgrounds than one. In the marketing and writing fields this is a technique of presenting something in threes, as that is known to increase appeal. Remember the old stories... The Three Musketeers, Goldilocks and The Three Bears, the old nursery rhyme Three Blind Mice? Marketing taglines often focus on three adjectives for their products; "Thinner, Lighter, Faster". It appears everywhere; in mathematics, statistics, chemistry, aviation, military, diving-the rule of three is everywhere.
Needless to say, the rule of three is not without its relevance in investing. Every investor, before he makes the first investments in the markets must be aware of this “Rule of Three Years”. Simply put it says if you require the money within three years of investing in the markets, it should not be in the equity markets at all!
We all know that markets are volatile. They can rally on the day RBI announces a surprise rate cut and shed 600 points to end lower than the previous close. They react to news. And they can remain suppressed for a time if the economic and investment climate is unfavourable.
However over long periods equity investments generally tend to rise higher. The logic is simple. Taken as a whole over long times, businesses would generally make money. They may go through unfavourable seasons but they would fall back in favour, because life goes on… and buying and selling of goods and services would resume.
Therefore the money that would be required for living expenses, paying off debt, rent, buying a car etc within the next 3 years should never come to the equity markets. If you needed your money that was invested a short time ago in the middle of the “unfavourable season” then the result could be disappointing.
This money that is required within 3 years can be invested anywhere else – FDs, RDs, liquid funds, short term debt funds, multi asset funds etc but not equities.
Rule of 3 years of investing in taxation
Why does ELSS have a 3-year lock-in period? One of the reasons why various tax-saving instruments have specified holding periods could be to ensure that they are not discarded immediately after claiming tax benefits. And so that tax savers are induced to the good practice of saving and investing for the long term, even if by compulsion.
Also the Fund Manager of the fund knows that the money he has received today will be in the fund for at least 3 years, thus it could be that he focuses on stocks which have a longer term appeal than one which has to be sold within the month for redemption.
ELSS has the least mandatory holding period among all the tax saving instruments. This seems to be so because market-linked financial instruments are still not popular. They are viewed with caution by the masses, majority of which are conservative. And to date, mutual funds are push-products. They need to be sold to people; they wouldn’t go looking for it themselves.
The “optimal” holding period
All right, so three years could be thought of as the minimum recommended period for investing in shares. But what about the optimum holding period; or is there even one?
We have always emphasized that investments should always be linked to goals. If the goal is retirement, child’s education or marriage there would be many years, hopefully at least a decade or two, to save and invest. vv We have covered in earlier articles that in the past 35 years S&P BSE Sensex never gave a negative return, whenever investments made in it were held for 10 years or more. Kindly click on the link to read the last article with detailed statistics and interpretation on optimum investment period.
Please note that the above chart is to explain / understand how equities have performed in the long term. The chart shall not be considered constructed to ensure minimum / indicative / guaranteed returns or safety from equities. Past performance may or may not sustain in future.
As seen above, when investments were held for short periods like1 year sometimes the returns were negative.
So, if some part of the money that you invest is not meant for any goals in particular, you can target a holding period of 10 years or more and then proceed to redeem it. Of course, it doesn’t mean investments made for shorter durations of 3, 5 or 7 years have always failed.
Think about your goals and keep any investments linked to goals coming in the next 3 years away from equities. For the rest, equities are the place to go; where they’d have the potential to grow over the years and help you reach your goals. Please consult your financial advisor about individual investments.
Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.
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