Index investing is an excellent bet in the long term

Paras Jain/Mint

POWER POINT

3 min read . 27 Jul 2021

We performed a detailed study on Nifty 50’s rolling returns data for the past 25 years. Imagine one invested ₹10 in the Nifty 50 index on 1 January 1996 and held on to it for a year, then did the same on 2, 3 January and so on for the next 25 years (2021). This will have a fair share of both, good (when the markets were low) as well as bad days (when markets were soaring high). Now, when we perform the same exercise to calculate the 2-, 3-, 4- and so on to the 15-year holding period (HP), we noticed that the gap between the maximum and minimum returns kept narrowing as the investor’s HP increased. In fact, in the seventh year, the investor’s minimum returns jumped out of the negative territory.

There has been no seven-year (7.3 years to be precise) period in the past 25 years in which one would have lost money in the index. We can pick any seven years in the past 25 years and the index would have earned at the very least 3-4% and a maximum of a whopping 28% return. This is proof enough that the markets are volatile only in the short term. It is this volatility that makes equities risky. But if one were to stay patient and remain invested for the long haul, the risk is eliminated!

Still unsure? Let’s talk odds.

To calculate the probability of returns, we went back and counted the number of times an investor would have earned the respective returns for each HP. From a statistical viewpoint, with a 1-year HP, an investor stood a 70% chance of not losing even a single penny, a 58% chance of gaining a return of over 7% and the probability of earning a 10% return would be around 53%. Not bad, right? But what’s even more interesting is that as the holding period is increased to, say, over seven years, there’s no chance the investor would lose his/her money, turning index investing low risk in terms of probability. And earning a 7% and 10% return now becomes 90% and 63% probable, respectively.

In fact, the study revealed that the odds of earning a good return keep magnifying with a longer time frame. Note, however, that while past returns are a guide to estimating probabilities, they are no guarantee of future returns.

Probability of returns: Finally, with an over 14-year holding

period, the investor would with high probability make a return of no less than 7% through the Nifty 50 index. Intriguingly, from all the 6,266 price data points, calculating the 15-year HP return gave us 2,516 returns data points, each one of which boasted a return greater than 9%. Simply put, if an investor were to hold on to his/her investment for 15 years, the returns have a good chance of shooting above 9%. Let’s say, for example, if we would have invested ₹1 crore and compounding it at 9% (CAGR), the end value would have been ₹3.64 crore after 15 years of holding. The real magic is all about being cool and patient.

The best part? These are just the minimum returns earned through index investing, without even taking into consideration the effect of dividends. Historically, the average dividend yield hovers around 1.5% per annum. This means that even a conservative assumption of, say, 1% dividend yield takes the investor’s total return to 10% (from the 9% previous certainty for a 15-year HP). Furthermore, if the investor would have decided to reinvest this 1% dividend yield in, say, any financial instrument, his/her total return exceeded 10%. If one is willing to be patient, it is more than possible to profit from simply an index investing strategy.

If past performance is any indication of the future, we can safely say that if you are in it for the long haul, index investing would make an excellent asset class wherein even a novice investor can earn superior returns, irrespective of investing in the market’s highs and lows. A diversified index balances itself as per the prospering sectors, sticks to its multibaggers and has a unique way of shredding its losers and rewarding the winners.