Why Risk in Equity depends on your Investment Horizon

Investor's misunderstand equity risk

Most investor’s don’t truly understand equity risk. This is explained below. 

General Understanding


Investor's don't truly understand how much Equity Risk Reduces over time

The reality is that equities are:

Highly Risky in short-term (1-3 years)

Very high volatility in returns and high risks of losing money.

Mid Risk in medium-term (3-7 years)

Both volatility and chances of losing money reduce substantially

Almost risk-free in long-term (>7 years)

Very sharp reduction in volatility and very low chances of losing money

Equity returns are not-linear

Economic growth & equity markets are cyclical. There are good years and bad years.

If you look at any 10-year period over the past 4 decades, you will see that each decade has a mix of very good years, average years and bad years.​

When you invest for the long-term, the good and bad years average each other out. ​

This is what makes equity Low Risk & High Return over the long-term (>7 years)

Equity returns over different time-periods

To understand equity returns better, it is useful to study how equity returns vary across time-periods over the past 20 years (Jan 20 – Jul 20). 

This 20-year period is a good representation comprising periods of strong bull markets & sharp market corrections. This includes:

Strong Periods

Investment driven boom (2002-08), Sub-prime stimulus (2009-11), Consumption boom (2015-19)

Weak Periods

Dot-com crash, sub-prime crisis, Covid, commodity volatility, rise in terrorism & geo-political concerns

In the short-term, your returns are very dependent on if you have invested in a strong or weak-period.

Over the long-term, your returns average out the good & bad years leading to high-returns with much lower risk & volatility.

This can be seen clearly in the chart below, that shows how much the difference between min, average & max returns reduces with time. ​

Assuming an investor could invest on the 1st trading day of any month, we analyzed how his investment returns would have varied depending on his investment holding period (1 year, 3 year, 5 year, 7 year and 10 year).   

Another way of looking at the same data, is to see the actual 1yr, 3yr, 5yr, 7yr and 10 yr returns based on different investment dates.​

As the data shows, equities can be highly risky over the short-term (less than 3 years).

While risk clearly reduces over the medium-term (3-7 years), what really stands out is how much risk reduces over the long-term (7 years).

For investor’s who held equity for 7 years of more, not only did they never lose money regardless of when they invested, but in over 95% of the time they earned well-above what they would have earned in any other asset class.