The investment horizon plays a vital role in investing. Talking specifically about mutual fund schemes, equity mutual funds may be more suitable for long-term financial goals. Equities may be volatile over the short term but carry the potential of wealth creation over the long term.
The debt schemes may be considered more suitable for short-term goals and emergency fund creation due to the relative stability of debt as an asset class. While some financial goals may be immediate or short-term, long-term investing has better potential for wealth creation. Here are five reasons why you should make long-term investments:
Achieving Long-term Financial Goal
It is always advisable to align the investment strategy with the financial goals. One should aim for long-term investments to achieve their long-term financial goals, including child's education, child's marriage, planning for a bigger house, retirement planning, etc.
Power of Compounding
Albert Einstein once said, "Compounding is the eighth wonder of the World." With long-term investments, investors can reap the benefits of the power of compounding effortlessly. Regular investments help the investors accumulate wealth, but the growth of such investments over the long term supports an exponential growth of the investment portfolio as the investment period increases.
For example, Rs. 10,000 invested monthly in a mutual fund scheme generating 10% annualised returns can help the portfolio value reach Rs. 0.77 crores in 20 years. However, given another ten years, the portfolio value increases by Rs. 1.51 crores to reach Rs. 2.28 crores with incremental investments of only Rs. 0.12 crores.
If we give another five years to the investments, the portfolio increases by another Rs. 1.55 crores to reach Rs. 3.83 crores. This simple illustration reflects the power of compounding that investors can extract with a long-term investment strategy.
Reigning over Short-term Volatility
Investing for the long-term helps reign over the short-term volatility, especially in equity markets. Investments held for the long term tend to reflect lower volatility since the short-term volatility gets moderated over a long time.
While there may be short-term spikes in the movements, the long-term movements exhibit a stable uptrend wherein the investors' long-term returns have been spectacular. For example, Rs. 1 lakh invested in 1978 in S&P BSE Sensex would have turned into Rs. 5.83 crores as of September 10, 2021.
Source – www.bseindia.com.
This translates into around 16% annualised returns over 43 years, even when the equity markets have seen severe market corrections due to several reasons, like financial scams, terror attacks, geopolitical tensions, pandemic outbreaks, etc.
Saving on the Exit Load
Exit load is generally applicable on different mutual fund schemes for redeeming before the expiry of a specified investment period. This period may range from seven days to two years, depending on the mutual fund categories and offer documents. When one invests for a period longer than the specified period, one can save the exit load, which directly eats into the investors' returns.
Tax Advantage
Long-term investments enable investors to take advantage of the tax benefits. There are special tax rates and exemptions for long-term capital gains, whether equity or debt schemes. The minimum period of investments specified for the classification of gains as long-term capital gains are 12 months for equity schemes and 36 months for debt schemes.
As against the maximum marginal tax rate of 30% for retail investors, the tax rate for long-term capital gains on equity schemes is 10% (plus applicable surcharge and cess) without indexation. For debt schemes, the tax rate is 20% with indexation benefit. Further, the investors can also benefit from Rs. 1 lakh exemption per year for long-term capital gains from equity shares and equity funds in aggregate.
Note: The tax provisions, as mentioned in the article, are for illustrative purposes only and are updated as per the Union Budget 2021 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.
