If you have been making stock market investments for some years, then you would have regularly heard about the benefits of long term investing.

But what exactly are long term investments? And is your long-term same as our long-term?

This article explores these questions.

Equity is not the only asset class suitable for long term investments. There are other financial instruments that are equally suitable for those with long investment horizons. For example – bank deposits, bonds, debt funds and even gold.

But when it comes to returns, equities have been an out performer among all asset classes in last 20 years. Just have a look at the average returns of these asset classes:

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So even though one must follow asset diversification and invest across all assets, it’s important to not miss equities if the target is real wealth creation. There is no asset that can beat the returns of equity in long run.

Sensex, a good representative of Indian stocks has grown a whopping 26 times in last two decades (source – press release February 2014 – Axis Securities). No other asset class including can boast of such returns.

And did we tell you that there have been individual stocks that have given eye-popping returns in past? Like thousands of percentages! We will disclose these multibagger stocks in later part of this article.

But in spite of proven superiority of equities, most Indians still don’t invest in stocks.

According to Livemint’s data, equity ownership constitutes only about 7.8% of the total financial savings of the Indian Households (in March 2014, excluding real estate).

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Image Source: Livemint (2014)

This is much less than what US households have at 45% (source: Axis Securities’ data).

Now since the start of 2003, Sensex has given average returns of almost 19% compounded annually. This shows that markets have rallied in the past decade even without much participation of retail investors. And this lack of understanding about equities being a potent tool for wealth creation is what has resulted in retail investors and HNIs being unable to benefit from the rise of stock markets.

Those who don’t invest in stocks fail to understand that investing in fixed instruments giving 7% to 9% per annum (before tax) doesn’t help because the average inflation in India is high. The value of money itself decreases every year.

Equity on other hand historically proven to be capable of beating inflation comfortably if invested in for the long term.

That brings us back to where we started: How long is the long term?

There is no one right answer here. But if perceptions of most people are to be considered, then it ranges from 3 years to 5 years.

We are of the view that anything less than 5 years cannot be constituted as long term. Markets are volatile in short term and hence, risks of capital loss are more. Also, when it comes to investing in stocks, the real ‘long-term’ depends on business growth of the company being invested in. Looking at just a few months or quarters worth of business performance doesn’t help in correct assessment of full dynamics of the business. And if the business is growing consistently and profitably, then one can (and should) hold the shares of the business for many years.

Let’s take an example to explain this:

Suppose you had invested Rs 1 lac in Sensex at the start of 2003 (start of bull run). Value of your investment would have crossed Rs 6 lac at the 2008-peak, i.e. more than 6 times in 5 years! But then, the 2008-09 crisis would have brought down your investments to Rs 2.4 lacs in March 2009.

Many people who did not understand the power of staying invested or making fresh investments in stocks during crisis (http://www.researchandranking.com/crisis-investing/), would have exited by then. Such people fail to recognize that with crisis comes the opportunity to buy shares of fundamentally sound companies at extremely cheap valuations.

But had they stayed invested, their investments would have again risen to Rs 6 lacs by 2010-end.

This is what happens in long term. But markets in long term require patience.

Again from late-2010 to late-2013, markets did almost nothing. And then after a 3-year lull, they shot up. That upmove would have taken the Sensex based stock portfolio to Rs 8 lac.

Had the investors exited in between (say 2009 or in between 2010-2013), the returns would have been much lesser.

Here is the summary of this scenario, which clearly tells why long term investing works:

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If the investor had stayed invested through this period (2003-2015) – which is definitely long-term, then in spite of facing the volatility and uncertainty, he would still be sitting on a substantial corpus after having just invested Rs 1 lac.

But this was about markets in general (Sensex). What about individual stocks? There are thousands of stocks in markets and not all will give you such stellar returns.

Hence it is also very important to pick the right stocks. And fundamental research plays a very big role in identification of those right stocks.

Had you invested in Unitech in 2008 at Rs 500+, you losses now would have exceeded 99%, as the current share price is less than Rs 5.

But had you picked the right stocks like say Eicher Motors or Page Industries, you would be sitting on gains like 22,000% (since 2003) and 4400% (since 2007) respectively. These stunning absolute returns translate into about 51% annual returns! That is the real power of long term investing when you invest in right asset and pick the right stocks.

Here are some more examples of wealth creation by stocks:

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Agreed that returns from these multibagger stocks (in above table) look unearthly. But they are real and investors have got those returns.

You need to convince yourself that to achieve inflation-beating returns and more importantly, participate in the real wealth creation process; you will have to make stock market investments backed by sound fundamental research.

There is no other way and there is no point waiting years to get convinced about starting to invest in stocks.

This asset class has done it in the past and will do it again in future. It’s up to you to decide whether you want to create wealth or sit on the sidelines.