Putting to rest the definition of ‘long term

Since the demonetization, the Mutual Funds industry in India is growing rapidly and so are the terms that are coming along. One such term is 'long-term'. The definition of long-term varies from people to people.

As far as the Income Tax Department of India is concerned, for the calculation of Capital Gains Tax, whether invested in equity or equity-dedicated mutual fund, long-term means anything which is more than one year. In the case of other investments, it is three years and more. But if we see from the investment perspective, then one year is a short period for investments in Equity.

To understand what is long-term, let us first understand why long-term? And the answer for the same is to reduce the effect of volatility. The longer the period of investment, the lesser is the volatility. On the contrary, the shorter the period, the greater the volatility, which may also lead to a capital loss.

Let’s look at it in a different way. The stock market often runs in cycles. It takes around five to seven years to go through a cycle of Growth, Stagnation, Fall, and Trough. To expect good returns, the investments must be held for the whole cycle.

To understand this let's assume investment in Sensex. The rolling return in Sensex since 1979 to 2017 shows that, over the period of one year, the Sensex earned maximum returns of 266.88 per cent and minimum returns of -46.78 per cent. Over the period of five years, the Sensex earned maximum returns of 52.97 per cent and minimum returns of -4.77 per cent. Over the period of 10 years, the Sensex earned maximum returns of 34.68 per cent and minimum returns of -2.09 per cent. Over the period of 15 years, the Sensex earned maximum returns of 25.57 per cent and minimum returns of 6.49 per cent. This means there seems no loss for investments made in Sensex for 15 years. All the figures are annualized figures.

Now it is clear that shorter the period, greater the potential gain, but also greater the possible risk. On the contrary, the longer the period, potential returns are stable and lesser is the possible risk. From this, we may conclude that long-term is anything above 10 years.