News: Why long-term investing is not about buying and forgetting-04-05-2020
Updated On: May 04, 2020
Why long-term investing is not about buying and forgetting
Since all asset classes move in cycles, investors need to time the shift between classes. The shift can be based on absolute returns—sell any asset class that gave x% plus absolute return in the last few years— or based on internal valuations.
Average long-term returns from Indian equity markets were at best moderate before the Covidinduced crisis struck. Returns are low now. The 10-year Sensex CAGR stands at 6.42%. This is lower than the 10-year inflation CAGR of 6.92%. This means equity has failed to protect against inflation over the past 10 years.
Analysis of systematic investment plans (SIPs) throws up similar results. A person putting in Rs 1,000 a month through SIPs would have invested Rs 1.2 lakh over the past 10 years. The value of the investment now is Rs 1.7 lakh—a return of 6.78%. This is also lower than the 10-year inflation average. Does this mean long-term investing is not worth it or equity has failed long-term investors? No. This just busts the myth that ‘long-term investing is buying and forgetting’. Long-term investing is like planting a tree. The tree will take years to bear fruit. But you can’t forget about it in the meantime. If you don’t take care of it, the tree may die before it grows to bear fruit.
Risk-return theory
All asset classes carry some element of risk, and equity is high risk. The risk-return theory states “investors demand high return for taking high risk”. This should not be misinterpreted as “investors will get high returns if they take high risk”. Let’s assume you are getting the exterior of your house repaired. The cost will be low if the work is on the ground floor, but more for the higher floors. Since the risk involved is higher for higher floors, the contractor will charge you more. However, you are not going to pay more if the contractor employs some risky strategy to do repairs on the ground floor. Similarly, the market will reward you if you take ‘necessary risks’, but not ‘reckless risks’.
Churn between asset classes
Since all asset classes move in cycles, investors need to time the shift between classes. The shift can be based on absolute returns—sell any asset class that gave x% plus absolute return in the last few years— or based on internal valuations. For example, the Sensex trailing PE usually trades in the range of 12-28 and the 20- year average is around 19 now. The market generated a good selling opportunity in December 2019 when the Sensex PE crossed 28. There was a good buying opportunity in March 2020 when the Sensex PE went below 16, a10-year low.
Churn between products
Selecting the right asset class is only half the work done. Investors have to churn products within that. For example, midcaps were trending till the end of 2017 and large-caps pushed the markets up in 2018 and 2019. Sector rotation is another important factor. IT was the hot sector in 2000, but did not participate in the 2008 rally. Similarly, the leaders of the 2008 rally like realty, infra and capital goods are still languishing. The leaders of the recent rally like financial services may languish for years in future. Actively managed funds beat the broader indices only because they churn portfolios.
Investors of other asset classes also have to follow a similar strategy if they are using market-linked products. For example, they should shift from long duration funds to short duration funds when interest rates are rising and vice versa.
Churn based on tax laws
Since Indian tax laws keep changing, you need to adjust your portfolio accordingly. Several investors used the fund of funds (FoF) route for tax advantage. However, this strategy became inefficient when equity became tax free and FoFs were taxed as debt funds. Reintroduction of 10% tax on LTCG from equities has changed the equation again. Since indexation is not allowed here, actual tax incidence on equity will be higher than in debt funds.
Churn based on goals
A churn can become necessary when a goal is approaching. It is better to shift from equity to debt when a goal is 2-3 years away. A churn can happen even if you adopt a debt-only approach. For example, assume you want to invest in debt funds for a goal that is 5 years away. You have two options: park the money in a fixed maturity plan of 5 year duration; Or, park in a normal debt fund with 5 year duration profile. In the first case, duration of the portfolio comes down with lapsed time—after 4 years, the time period to goal and portfolio duration will be 1 year. However, if you invested in a normal fund with 5 year duration profile, the time period to goal will be 1 year, but the portfolio duration will remain 5 years. Since this is a mismatch, you will be forced to shift to an overnight or liquid fund.
