Generating positive returns and building wealth is probably the aim of most investors. And a very important factor in generating returns is the investment tenure. The time frame of your investment has significant impacts. Whether it is a short term investment of 2 to 3 years, or a long term one with tenure of 10 years, your returns are never the same.
Before we Begin…
Before we begin, here is a point to bear in mind. It is important to clearly define what you want to achieve or fulfill in life. Being aware of your goals gives you an idea of what exactly you would have to invest for. Clearly differentiate between short term and long term goals. This would help you decide where to invest and for how long the investment should be.
Here are five reasons to explain why looking long term may fetch you more.
- Risk and Investment Tenure
Risk is the possibility of your money increasing or decreasing in value from your expectations of the investment. So wider the range of possible outcomes, the greater is the risk you experience. The time you stay put in an investment impacts your risks. A long term investment lets you withstand the ups and downs of the markets and handle more risk in comparison to a short term one. Reason- when you lengthen your investment horizon, the average annual rate of return earned over the years, is less variable. Thus, your risk for the return is far lower.
- Power of Compounding
The concept of compounding is of vital importance when it comes to investing, because of its direct relation to time. Long investment tenure, fetches higher gains from compounding. Compounding works exponentially over time, with the interest being added on to the principal, which in turn becomes the new principal. So, in the long haul it fetches you more. And as compounding yields more for a longer tenure, start investing early in life. By doing so, you give more time for your money to plough back the interests.
- The Add-ons
Over time investments pay further add on benefits such as dividends and bonus. Dividends from investments are a great way to boost your overall returns from the investment. They neutralise the impact of market volatilities giving you an added advantage.
- The Capital Gains Aspect
Any kind of tax liability significantly impacts the returns from your investment. The tax on the gains made from an investment is known as capital gains tax. Capital gains on investment could be categorized under long term capital gains tax or short term capital gains tax on the basis on the period of holding of the investment. The categorisation varies with different asset classes. For example in real estate, long term is after a 3 year holding, where as in equity(mutual funds or stocks), the holding period for long term capital gains is 1 year.
The long term capital gains tax for equity is 0% and the other asset classes are taxed at 10% or 20 %( depending on the asset). Short term capital gains tax is far higher. Gains from assets are included in your income and are taxed as per the slab rate, except for equity which is taxed at 15%. Thus, staying invested for a long term reduces your tax liability significantly.
- Market volatilities and price fluctuations
Volatility in the market isn’t uncommon and predicting market movements are near impossible. For a short term investor, dealing with these volatilities may be quite a constraint. Often short term investors bear the brunt of such disturbances resulting in investment losses. Over a longer term, investments go through various cycles and see different highs and lows of the market. Staying invested sails you through the relatively short term market movements. Long term tenure has the capacity to weather small market disturbances.
With historical data, staying invested for a longer tenure proves to generate substantial returns. Apart from the above reasons, short term investors require to constantly keep track of market movements, index and NAVs to capitalize at the right time. A long term investor could be far more relaxed with minimal monitoring required. From an investment perspective plan for your goals along with a regular evaluation of the investment strategy and portfolio, to ensure you are on the right track and your investments continue to work towards your goals.
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