Equity Investments: The Time-Returns Relation

One of the most important factors that determine investment returns is the time frame of investments. It has long been argued that equity investments are for a longer period. However, this ‘period’ is very loosely and vaguely defined. The time period for an investment, especially in equities, can vary from a second for a day trader to more than decades for value investors.

To come out with a time frame where investment on equity earns the best returns, we studied the BSE Sensex data for the past 23 years as a proxy to equity investments. We took into consideration 5 different time periods, i.e. 1, 3, 5, 7 and 10 years to zero in upon the optimal investment horizon. The rolling returns are calculated in the following way - the first 1, 3, 5, 7 and 10-year periods are calculated from January 1, 1990, the next time period is calculated from January 2 onwards, and so on.

After analysing the data, it becomes clear that as the investment horizon increases, the probability of incurring a loss reduces, as you can see in the figure. Besides this, the risk (as measured by standard deviation) also decreases with an increase in the investment horizon (see figure).

For example if you had an investment horizon of one year and invested on any day over the past 23 years, the probability of the instances of making money would be 65%. This increases to 96% for a 10-year period. Most of the negative returns that were recorded for a 10-year investment horizon were due to those investments that were made during the height of the Harshad Mehta scam and the following 10-years where we saw another scam by Ketan Parekh, which led to a fall in the Sensex.

Why longer period investments in equities yield better returns is that the markets often move on greed and fear in the shorter term, making the stock prices inflated or depressed respectively. Nonetheless, fundamental factors outweigh the psychological factors in the longer period.Of course, there must be some middle ground between the return potential in a 1-year horizon and a holding period as long as 10 years. Our study shows that a 3-year period is the best time horizon for a long-term investor. The returns are as good as those for a 10-year period, while the instances of negative returns (in %) is similar to those over 5 years (see figure).

An important caveat here is that the starting and ending points of an investment may change the above results. However, it will only deviate to a certain extent and will not make the study irrelevant.