Miraculous Assured Returns By Treating Equity As Long Term Investment

Whenever retail investors start taking direct exposure to equity, they also develop the habit of daily checking the share price movement. On many occasions, it reaches to an extent of installing application on mobiles for tracking price ticker, subscribing to frequent updates on news and price movement on stocks. This over-obsession of tracking shares is very detrimental to the financial health of the investors and is against the basic principle of investing. Investing is minimising the risk to generate returns over a long period of time.

Investors have been made to believe that equity is a very high risk instrument and if someone does not have the time to monitor the performance of the instrument, they should not invest. Investors also believe that fixed deposits (FDs) or bonds are risk-free and what generally happens is that after investing in a bank FD, we seem to forget about the maturity and renewal. If we can recall, five years ago retail investor were able to earn 9% on fixed deposit (Government of India 10-year bond yield was 8.9% in Feb 2014), but do we still earn the same rate of interest? In the current scenario, banks auto renew the fixed deposit at ~6.5% and whenever the retail investor realises that his FD is renewed at such a low rate of interest and decides to withdraw funds to redeploy, bank would also charge 1% penalty for foreclosure. In finance, we call this as reinvestment risk, which is defined as the probability that the investor will not be able to redeploy the money at the original rate.

In this study, we intend to explore the returns of equity over different time frames. We used CNX Nifty index to validate our understanding of risk and return and obtained yearly index values starting 25 June 1996 till date. We then calculated rolling CAGR from 1 year to 15 years. We also obtained 10-year Government of India bond yields from 1996 to 2019.

Analyzing Risk

We calculated standard deviation as a measure of risk for each column. Observe that standard deviation is maximum for returns calculated for one year period and decreases as the holding period increases. The standard deviation is minimum when the holding period is 13 year and more. What is most interesting to observe is that the standard deviation of Government of India bonds over the long term holding is similar when reinvestment risk is considered. This brings out a very important aspect of investing—that the risk to the investor is more when holding period of equity instrument is lower and it decreases over time. Risk of investing in equity and bond is not different in the long run. 

Analyzing Return

Now let us look at the returns. Since the risk level at holding period in equity for 13 years is similar to that of government bonds, let us analyse the returns for 13-year holding period. Minimum return value in the column for 13-year holding period is 11%, which means that if someone invested in Nifty shares in 1996 and sold it in 2008, they would have earned a return of 11% as compared to minimum return on Government of India bonds, which is 5.73%. Maximum return for holding period of 13 years is 17%, as compared to GOI bonds which is 13.9%. This difference of excess return of 3% with compounding effect can be very critical in investing. Observe the values in table-2. If money is compounded at 13% for 20 years, Re. 1 invested would become Rs.11.5 as compared to Re. 1 invested at 17% for 20 years becomes Rs.23.106, which is twice the amount of money compounded at 13%. 

We also need to remember that since we used index values to calculate returns, we are not factoring the dividend yield. Even if we assume dividend yield to be 1%, then given the same amount of risk, the excess return earned by investing in equity is 4% more than that of bonds.

Retail investors will surely benefit from the equity markets, but the holding period has to be long. We believe in Warren Buffet’s words, “The stock market is designed to transfer money from the active to the patient.”


Prof Ruzbeh. J. Bodhanwala and Prof Shernaz Bodhanwala are faculty at School of Business, FLAME University, Pune.