Poll: The investment horizon - Views on News from Equitymaster

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Poll: The investment horizon

Jan 7, 2004

The equity markets are on a roll. Investors have earned returns ranging from 100% to 500% and even more on their investments in 2003, which is simply astounding from any and every measure. Even a passive investment approach like investing in an index fund would have returned a handsome 70%+ (BSE-Sensex gained 73% in 2003). This kind of movement in the indices does not come often, wherein such huge returns are attained in such short time periods. Further, most of the investors would have barely managed to keep pace with the index returns owing to the fact that while some would have entered late others would have exited early. And it is this act of short-term investing, which is precisely what affects investment returns. In a recent poll conducted by Equitymaster, wherein we asked the readers opinion with regards to their understanding of long-term investment, it was rather encouraging to know that 31% voted for a period greater than 3 years. While the maximum number (42%) voted for a period between 1-3 years, 27% restricted their long-term investment to 1 year!

In our view, long-term investment is strictly for a period over 3 years. In fact, we, at Equitymaster, never advocate short-term style of investing as we feel that this act of getting in and out of stocks, in trying to make a quick buck, seldom pays in the longer term and is a strategy not worth practicing. Buying and selling shares at quick intervals only leads to escalation in costs for the investors, as he pays brokerage and depository charges everytime he executes the trade. Further, since the mindset of the investor is to hold the stock for a small period, it generally leads to taking decisions in haste and the investor is often caught on the wrong foot.

For e.g. an investor who has bought a stock at say, Rs 100, and the market (or the stock) goes in for some correction, the investor, because of his urge and impatience, often squares off his positions at a lower price (say Rs 95). However, here, in this scenario, the investor not only losses 5% of his investment, but also the brokerage and depository charges on either side of the trade, which could total to anything about 2%-3% of the trade value. So, the actual total loss could escalate to 7%-8%. And all this is primarily because of a short-term view. Similarly, if we look at the other side of this short-term story, the possibility of an investor booking profits at Rs 120 is very high because of his satisfaction with approximately 17% returns (don't forget the buying/selling costs).

However, while we firmly believe in equity investments with a long-term horizon, it does not mean that one should just purchase the stock and forget it. In fact, this is one aspect, which is often used to criticize the long-term investment style. It must be noted that long-term investment is not about buying a stock and forgetting about it. Periodic checks of the company's performance, the sector it belongs to and the policies pertaining to the particular sector are all necessary actions to be taken by an investor. And this is of higher relevance to investors who directly invest into equities rather than through mutual funds, where a fund manager has the responsibility of doing the above tasks and taking the necessary and timely actions and precautions. However, it must be noted that poor performance by a company for a couple of quarters, while its fundamentals remaining intact, does not warrant the stock as a bad investment option.

Further, alongside the argument of investing for the long-term, we would also like to bring forth the systematic style of investing pattern, also known as the dollar-cost averaging, wherein an investor invests a specified amount every month into equities. One big advantage of this investment style is the fact that in this, the cost of acquisition tends to average out. For e.g. If in a particular month, Rs 100 would buy 10 shares of a particular stock, and the stock price falls to Rs 5 in the following month in the normal course of market movements, the same amount next month would help one buy 20 shares of the stock. Thus, effectively, the investor would buy more units at lower price and lesser units at a higher price.

To sum it up, from the stock markets perspective, a price-earnings ratio of around 13x-14x FY05E earnings still leaves some room for re-rating of the Indian bourses. This could continue to attract Foreign Institutional Investors (FIIs) money into the Indian stock markets. It must be noted here that FII's invested over US$ 6 bn in 2003, and the inflows have continued to remain strong at the start of 2004, which further cements the fact that Indian stock market valuations are attractive. Thus, investors should adopt a long-term approach and overlook the short-term volatility to reap larger long-term gains.

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