Mutual funds can make for an ideal investment choice, especially for investors who are aiming for wealth creation in the long run. With a wide range of fund options, these can benefit investors who are looking for capital gains and also those who wish to have a regular income.
There are different types of mutual funds available in the market today, such as equity funds, tax-saving funds, debt funds, thematic funds, index funds, money market funds, etc. Before investing in any of these, an investor needs to carefully consider the investment amount, investment time horizon, and risk appetite. This will help in mutual fund scheme selection to further achieve financial goals.
One important factor that helps an investor make the right mutual fund choice is the time horizon of investment. Most experts suggest that mutual fund investments are best suited for long-term investors. Here, we will explore the importance of a long-term investment horizon for any investment and how investors can benefit from it.
What are the benefits of investing for the long term?
Listed here are some of the key benefits that can be availed by investing for the long term:
Advantage of law of averaging
There is always an equal amount of upside and downside risk with short-term investments, since these are mostly lump sum and are easily impacted by market volatilities. When it comes to long-term investments, if an investor invests during market upswings, he/she can average out the cost of investment to a lower level through periodic investments over a longer term.
Higher gains through compounding
To understand the benefits of compounding in long-term investment horizons, here is an example:
Suppose Mr. Rahul invests Rs. 1 lakh in a mutual fund every year from the age of 25 till his retirement age of 58 years. In all, he invests Rs. 34 lakhs till he attains retirement. With a simple interest of 10%, his net returns will be Rs. 3.4 lakhs. Therefore, including capital returns, his earnings will be Rs. 37.4 lakhs at maturity.
From the perspective of a mutual fund investment, investors can have a reinvest option for long-term investments. Using the above example, this investment will have a compound interest of 10%. Thus, with an investment of Rs. 1 lakh in the first year, the value of Mr. Rahul’s capital investment will reach Rs. 1.1 lakh in the second year (Original investment = Rs. 1 lakh + interest earnings = Rs. 10,000. Total = Rs. 1.1 lakhs). By reinvesting the amount each year for 33 years, his investment corpus will reach approximately Rs. 2 cr at the time of retirement or maturity.
As we can see, the difference between the returns from simple interest and compound interest investments is substantial. The higher returns are possible only with a long-term investment horizon.
Volatility refers to market fluctuations that may impact the value of any investment over a period of time. The degree of volatility depends on the investment type. For example, if an investor has invested In equity mutual funds, the impact of volatility may be higher in the short run due to constant movements in the prices of stocks that the fund is invested in.
No matter the fluctuations, an investor must note that these are not losses and are notional in nature. Investors who have a longer investment horizon benefit from the smoothening of these fluctuations and resulting positive returns in the long run.
Easily achieve larger financial goals
Long-term investment horizon allows investors sufficient opportunities to easily achieve life goals. With enough time on hand, investors can be in a better state to plan their investments and identify income sources. Instead of making a lump-sum investment in a single avenue, investors can break up funds into smaller SIPs that can be distributed across different funds spread over a longer term. This also helps in imbibing savings and investment discipline to further achieve long-term goals.
For example, if an investor wants to build a corpus of Rs. 50 lakhs in a 15-year horizon, a monthly SIP of Rs. 10,000 can help in achieving this. However, if an investment horizon is cut short to 10 years, the investor will have to invest a larger SIP amount of Rs. 21,600 to accumulate the same corpus.
With long-term investments, investors also don’t have to worry about constantly tracking the smallest of market movements.
Tax benefits from long-term investment horizon
Apart from compounded returns, investments with a long-term horizon offer reduced tax liability. Long-term capital gains are taxable at relatively lower tax rates when compared to short-term gains.
Equity mutual funds
In equity fund investments, the long-term capital gains refer to gains made over a period of more than 1 year from the time of initial investment. Hence, if an investor stays invested in an equity fund for more than 1 year, any gains of up to Rs. 1 lakh from the investment are exempt from tax in the hands of the investor. Gains above Rs. 1 lakh are taxable at 10%.
Debt mutual funds
In case of debt fund investments, a long-term horizon means more than 3 years from the time of initial investment. Long term gains from these are taxed at 20% (including applicable cess). Thus, an investment horizon of over 3 years in a debt fund allows investors to benefit from indexation. With indexation, the initial investment amount can be adjusted to consider the effect of inflation. This helps in lowering the tax liability on overall gains.
Long-term investment horizon requires a substantial amount of commitment on the investor’s part. At the end of a long period, investors can meet their goals by redeeming their long-term investments. In long-term investments, the overall benefits are not just dependent on how much you invest, since it is equally important to consider how much you will end up saving.
Long-term investment horizon generally ranges between ten or twenty years and, in some cases, even longer. Long-term investors are open to larger risks in return for higher rewards.
All mutual funds carry some degree of risk, therefore, an investor may lose some amount or all, depending on the securities composition and related performance in the fund portfolio. Every mutual fund has a different risk profile, therefore, investors must check for the risk rating of the fund before investing.
It makes sense to invest in equity funds or index funds if the investment time horizon is approximately 10 years since these tend to fetch higher returns in the long run.It also depends on your risk appetite.
SIP or systematic investment plan can make you rich if you identify the right scheme to invest in and adopt a financial as well as investment discipline to remain invested for a longer time horizon.
Equity mutual funds are preferred by most Indian investors to maximising their returns in the long run. Apart from this, investors use low-risk options such as PPF, NPS, etc to balance the overall risk in their investment portfolio and with the objective to maximise returns.