How long should you stay in the market?
Most stock market reports state that an investor should hold for the ‘long term’ to improve his equity returns… that equity offers the best ‘long term’ returns… ‘long term’, ‘long term’.. But what is the definition of ‘long term’? Is it 2 years or 20 years? In order to offer an answer to this question, a detailed study has been undertaken taking the closing BSE Sensex numbers from 2 Jan 1991 to 12 Dec 2005. Annualized returns were computed for 1 to 10 year rolling periods (here is an example to explain the meaning of rolling periods. In the case of 1-year rolling periods, the average number of trading days was 236 days and there were 3,299 1-year rolling periods – 2 Jan 1991 to 17 Feb 1992, 3 Jan 1991 to 18 Feb 1992, etc.) Then the number of rolling periods when investment returns were positive was taken as a percentage of total rolling periods. For instance, in the case of 1-year rolling periods, out of the total 3,299 rolling periods, 1,878 rolling periods offered positive returns (i.e. 57 per cent of total rolling periods). The next step was to compute the average profit and average loss one would incur based on profits and losses of all rolling periods. For instance, in the case of 1-year rolling periods, the average profit was 34 per cent and the average loss was 15 per cent. Lastly, the maximum profit and the maximum loss was computed. For instance, in the 1-year rolling periods, the maximum profit was 283 per cent and the maximum loss was 50 per cent. The analysis revealed that the number of rolling periods offering positive returns increased when the holding period became longer. For instance, while in the case of 1-year rolling periods, positive rolling periods were 57 per cent of total 1-year rolling periods, in the case of 10-year rolling periods, positive rolling periods increased to 94 per cent. However, the average profits beyond a 4-year period starting falling to levels where it does not make sense to invest in equity. Simultaneously, average losses also started falling beyond 4-years. Clearly, the analysis indicates that in our stock markets, due to high volatility, one should exit and re-enter the markets after holding for 4-5 years. This way, one can book gains and reenter during a slide.
