The paths you can take to invest in your future are endless. There are many publicly traded stocks to choose from, several types of investment options, and plenty of opportunities to invest on your own or with the assistance of a financial advisor. In short, investors should follow no set formula or path to achieve their expected numbers except for one: investing for the long term.
Investors who attempt to time the market or do short-term day trading cannot take advantage of the advantages of long-term investing. Here we will understand how long-term stock investments help us gain long-term profits.
Long-term investments can be defined as an investment that an investor holds for more than 12 months. These can also be in investment in shares. Unlike short-term investments, where investments are most likely to be sold in a short period, long-term investments will not be sold for at least one year from the date of investment. In some cases, investors may also choose never to sell them.
Investors generally choose long-term investments when they have excess capital that they can afford to keep invested for a long time. Investing in stocks for the long term also requires a lot of patience as the holding period can extend to decades.
Long-term investments do have the potential to generate excellent returns due to the power of compounding. The longer an investor stays invested in the stock, the higher returns the stock will be able to generate. Retirement planning is one of the key reasons most individuals have an investment portfolio.
If started early, individuals would have enough time until retirement to assemble a significant pre-retirement portfolio. This is due to the folding force.
Market fluctuations and other market-related risks such as inflation and downturns generally get offset by the rupee compounding over the long term. This will allow investors to generate an overall higher return in the end.
Historically, if you align your portfolio over the long term, you are more likely to make money. Although the stock has a roughly 50-50 chance of going up or down if we go by just the probability of happening two events, the stock can only go down to Rs. 0, but it can go up indefinitely. If you let your winner stocks go as high as they can, there’s a good chance you’ll see your portfolio grow in value over the long term, especially if you focus on investing in stocks of high-quality businesses.
Staying invested in stocks for the long term allows you to take advantage of compounding or the ability to reinvest your profits (e.g. dividends) over time to create even greater profit potential. Time is your best friend as an investor, and being able to reinvest a 3% dividend can make all the difference to your wealth after retirement. For example, simply pocketing a 3% yield will double your money approximately every 33 years, assuming no growth in dividends or stock prices. If you reinvested back into multiple shares of the same stock, your investment would double in almost 10 years!
One of the greatest aspects of long-term investing is that anyone can do it. It doesn’t take Rakesh Jhunjunvala to pick a well-run business portfolio and hold onto it for 10, 20, or 50 years. Sure, you won’t always be right, but don’t worry, even the greatest investors are wrong a third of the time – or more. But with long-term investing, there is no difficulty in learning different trading styles or platforms because you will not be an “active trader”.
One of the most beneficiary things about being a long-term investor is that being long-term investor helps you sleep better at night. You won’t have to wake up every day at the opening bell and check whether your portfolio has sunk or exploded overnight. It is likely that the companies you want to invest in for the long term are high-quality companies and, therefore, will have a relatively low propensity for volatility. Finding dividend-paying stocks that other long-term income investors are looking for is usually a good way to keep portfolio volatility low and stress levels minimal.
Remember the point above about everyone making mistakes at some point in the stock market? One important aspect of long-term investing is that it allows you to correct some or all of your mistakes. That doesn’t mean you should be picking up any stock you come across in the hope that your losing stock is heading higher. It means continuing to stick with companies that have demonstrated strong growth and perhaps joining companies whose business models are still intact but have fallen temporarily facing hard times. Riding the winners over the long term tends to correct many, if not all, of the “investing mistakes”.
When you are an active trader, commission costs can play a big role in your trading strategy. It’s not uncommon for intra-day traders to burn through thousands of rupees in commissions each year. As a long-term investor, you don’t have to worry about commission every day, or even a few dozen times a year when you add to your positions or maybe sell a stock once in a while. Commissions are a complete afterthought for the long-term investor, as their profits, in the long run, can easily offset the commissions paid.
Long-term capital gains (LTCG) on the sale of listed shares became taxable from April 1, 2018. In the case of investing in shares, long-term means a holding period of more than one year from the date of purchase. Long-term capital gains are gains from the sale of listed shares.
Before the Union Budget 2018 amendment, LTCG earned on the sale of shares in the hands of investors was exempt from tax. These shares were already subject to Securities Transaction Tax (STT).
Only short-term capital gains were taxed at 15%. The objective of exempting LTCG from tax was to increase investors’ participation in India’s stock markets. Thanks to the exemption, investors began to see stocks as a profitable investment tool. However, LTCG on equity funds is taxable after the Union Budget 2018.
Long-term capital gains (LTCG) above Rs 1 lakh from listed shares in a financial year are taxed at 10% without the benefit of indexation.
Investors are often advised to invest in stocks for the long term to reap the benefits of compound growth. The power of compounding is an important concept to understand and truly get the benefits of long-term investing. Compounding is similar to the multiplier effect, as the interest that is earned on the initial capital also earns interest, and the value of the investment grows at a multiplicative rather than an additive rate. The higher the rate of return, the steeper the growth and wealth creation curve. To give an example, an investment of just ₹ 1 lakh in year 1 at 10%, invested for 20 years, can compound to ₹ 6.72 lakh, giving a phenomenal return on capital of 672%.
Companies operate with the primary goal of making a profit and strive to continuously increase this profit. However, the various strategies and decisions they make shape their growth path in the process. This factor distinguishes good companies from bad, profitable from unprofitable. Profitable ones generate significant returns for their shareholders.
Company growth comes not only with scale but with operational efficiency, and that is a gradual process. The strategies adopted by the management make or break the growth path, and as investors, we must always study the company’s business model. It is also essential to have a macro perspective when managing a business and keep in mind various factors such as government policy, interest rates, and stakeholder claims (including debt and equity holders), among others.
The next part includes an assessment of the industry in which the company operates. An investor should assess how the industry will shape up to analyse whether there will be sufficient demand for the company’s growth in the future. For example, the dominant theme that has seen phenomenal growth is the FMCG sector. India is a developing country with strong growth prospects driven mainly by infrastructure and human capital development along with urbanisation in the country. As the country experienced growth in disposable income, the share of processed food consumption rose, and companies like Britannia benefited. If an investor had invested in Britannia at ₹196 per share in 2010, he would have made a 1940% return over 10 years. That’s the power of compounding.
So if an industry is expected to grow, a company in that sector with strong fundamentals will also prosper if all cards fall on the table. The company continues to grow on its capabilities and effective profitability as India continues to flourish in this theme.
Another growth success story is HDFC Bank. The financial sector has seen strong growth in India with banking penetration. As banking grew and formalised, banking stocks saw strong inflows and rose exponentially. HDFC Bank was part of this rally with an uptrend in its charts. Its revenues moved from ₹16,314 crores in 2010 to ₹1,22,189 crore in 2020, a growth of about 25% CAGR, while the stock moved from ₹210 per share to ₹1,385 per share, a rise of 6060% during the year, excluding dividends paid by the company.
These are examples of a company gradually growing to generate strong returns for its shareholders, and as an investor, you need to patiently be a part of this entire rally regardless of minor ups and downs. So when a company establishes its business and grows, the value of its stock increases, thus rewarding shareholders who stick with the company longer.
An investor must first look at the sector in which the company currently operates. This is crucial to understand because a sector that has strong growth potential can offer higher growth in value to the investor in the long run. Strong growth potential can come from the ability to expand or penetrate further into the market, or both. If the industry also provides more room for price increases over time as it expands, this will only further benefit companies. An investor should also assess the number of participants in the sector and the intensity of competition to determine the growth opportunities and threats it may face in the future.
Some industries have low barriers to entry where it is easy to start a business and compete. If the sheer size of the industry has high growth potential, a larger number of players can coexist profitably. An example of this is the FMCG industry, where there are a large number of competitors offering a wide range of products, but the scale of penetration and expansion is large enough for multiple companies to coexist profitably. On the other hand, in a mature, low-growth industry, even a small number of players can have a huge impact on the profitability of their competitors.
Companies in highly competitive industries will experience greater pressure on their profit margins. Therefore, it is more beneficial to look for such companies that are climbing the ladder to become one of the top players in the given sector, can navigate the sector well, and secure strong finances despite the competition. Also, look for companies for which there is growth potential in the form of moving up the value chain in a low-growth sector.
For example, Telecom companies moving from voice offerings to data and related services not only created a new revenue stream but also expanded the entire sector and various other opportunities. Look for companies that can build sustainable competitive advantages against other industry players. Companies in high-growth industries tend to have better prospects than companies in mature industries. Finally, it should be considered that an industry with great opportunities is also likely to attract more competition. To determine the opportunity available, the balance between the two opposing factors of industry potential and competitive intensity must be assessed.
Investors need to check the level of regulation that goes into the sector. The primary reason for regulation is to protect consumer and government interests over corporate interests. This results in an erosion of value as the benefits that would have accrued to the company are transferred to consumers and the government, leaving very little for the company’s shareholders. An example of this is the coal industry in India. The industry was under strict regulation regarding mining and pricing and was monopolistic, with mining rights granted only to Coal India.
Another example is government-regulated energy companies. These companies cannot earn excess returns beyond the specified limits. Industries such as consumer goods, automobiles, paints, and electrical items can be easily manufactured and sold in India without any significant government regulation. The higher the regulatory handle, the higher the regulatory risk because the revenues and profits of such businesses are to some extent under the control of the government and can adversely affect value creation and growth.
Any country’s economy moves in cumulative cycles with all other industrial cycles. As GDP grows, so do production, employment, and consumer incomes, increasing demand for products. Similarly, when GDP growth slows or declines, output, employment, and income fall. Sectors like airlines, cement, metals, infrastructure, housing, banking, and finance are examples of cyclical industries.
Industries such as consumer staples, information technology, and pharmaceuticals are relatively immune to economic cycles and therefore survive the stress of a down cycle for industry. Because of their relative resilience to economic cycles, these sectors are relatively more stable financial performers, and investors are typically willing to assign premium valuations to these firms because of their stability. Lower dependence on economic cycles also means that companies do not get stressed when the economy faces a downturn, providing some portfolio protection against these downturns.
Among the most critical factors in evaluating a company is the quality of its management. Effective management teams see and overcome the industry’s various challenges and transform their business models towards more attractive industries and higher growth in enterprise value. Assess whether the board of directors and management are different from each other because the BOD is responsible for larger company decisions while management is involved in day-to-day operations. Thus, the corporate governance process involves balancing the relationships and interests between the board of directors, founders, management, minority shareholders, auditors, and other stakeholders.
Effective handling of this balance demonstrates the strength of corporate governance. The higher and better the company’s corporate governance standards, the better the company’s minority shareholders are protected and the more certain that management will act in the shareholders’ interest. This can be found by going through the annual report.
While there are many other factors that investors need to consider, the above are key factors to assess and find long-term wealth builders.
There is a flip side to investing in long-term stocks. The drawbacks of investing in long-term stocks are as follows:
Blockage of the principal amount leads to heavy distress for investors during the spell of contingencies. Withdrawal of principal amount untimely might cause significant losses. Hence it is not that feasible to invest, especially for the ones who are investing without any liquid funds in hand. Here, capital gets tied up.
Impassive planning and short-patience investors find long-term investment to be ridiculous because of redundancy and unfaithfulness in market prices.
Since a lack of liquidity is created, investors find it concrete to survive because of an insatiable mindset, and these investments cannot be liquidated shortly, or else an ample amount of loss may be incurred on it.
While purchasing stocks in the long term, the company does not guarantee the return and marginal profits. It depends upon the market as to how the market reacts to the stock trade. If you have some money saved up, investing in long-term stocks can be one of the best ways to manage your risk and magnify your portfolio.
If you find these long-term stocks expensive, finding some penny stocks with a high yield potential of around 100% or more would add the same to your pocket.
Investing here can be a great idea since the risk factor is low, and new investors focus on the same. However, investors should focus on stocks of small and mid-cap only if they have experience in that particular portfolio and are ready to bear some risk.
Thus, patience and money to invest are the two factors to yield a stable return from your investment.
For ages, gold has been considered to be a good form of investment because it acts as a cushion in odd times. However, stocks and bonds have outperformed gold in long-term investment. But in a specific period, gold has outperformed stocks and bonds in returns. It acts as a hedge against inflation and also serves as a store of value.
Long-term securities comprise stocks, bonds, and ETFs (Electronic Traded Funds). However, marketable securities are considered to be current assets and are expected to be sold in a year.
Price-to-earning ratio is the ratio that estimates the company’s share price to its earnings per share. A high PE ratio indicates that the investors are expecting high growth rates. It means that the value of the stock is overvalued. So, one must look after the PE ratio as to whether it gives a good review after its analysis.
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