We all know that investing in the stock markets is risky - at least in the short term. But exactly how risky is it? And what does risk even mean?

**Risk**

There are several definitions of risk (Eg Volatility, Beta etc), some of them more academic than others.

We will use a more basic and intuitive definition - **the risk of losing money.**

So what are the chances of you losing money if you invest in the stock markets. And how can you minimize this risk?

**It turns out that the single biggest factor that determines your chances of making or losing money in the stock market is the length of time you invest for.**

For the analysis below, we took Sensex data from 1998 to 2016, and we looked at all consecutive 12-month periods for 1 year returns analysis (Eg Jan 1998 - Dec 1998; Feb 1998 - Jan 1999; Mar 1998 - Feb 1999 and so on), all consecutive 24-month periods for 2 years returns analysis and so forth. Instead of just taking calendar years, we take such continuously rolling time-periods in order to get a bigger and more representative sample of returns.

**Investing for the short term (1-2 years)**

The average annualized stock market returns historically have been about 14% per annum. But this average hides more than it reveals.

If you invest for just 1 year and look at your account at the end of the year, there is a 35% chance that you would have lost money.

How much loss are we talking about? The worst happened in 2008 and the loss was around 53%. But that's the worst. On average, the bad case is about a 7.5% loss.

Staying invested for 2 years instead of just 1 year decreases your chances of being in the red to 26% - lower but still significant. The worst case also improves to -23% annualized and the average 'bad' case is almost zero (-0.5%).

**This is what we mean when we say that don't invest in equity for the short term, especially for your essential goals.** Even though the average annualized returns are still 14%, but the chances of making a loss are also high.

**Investing for the medium term (3-5 years)**

As can be seen in the table below, 86% of all 3 and 4 year periods have had positive returns. So you would have lost money only 14% of the time if you stayed invested for 3-4 years. On average you would have made about 13% per annum, and the average 'bad' case is also positive now at about 2.8-3.8% - close to post-tax savings account returns.

Things further improve for a 5 year time horizon: 93% of all 5-year investment periods have had positive returns. The worst case is -7% annualized and the average 'bad' case is 5.4% - close to post tax FD returns for those in the highest tax bracket!

The average case for 5 year investments is our familiar 14% and the average good case (median of all good cases i.e. the 75-th % ile) is a whopping 20% annualized!

We can start allocating moderately to equities at these time horizons of 3-5 years.

**Investing for the long term (6-7 years and above)**

6-7 years or more is where investing primarily in equities is almost a no-brainer.

99% of all 6 year periods have given positive returns and so have * all* 7 year periods, with the worst case returns being a positive 2.6%.

**For a 7 year time horizon, even the below average cases have given returns of 8.9% - more than an FD, pre-tax as well as post-tax.**

**For 10 years even the worst case returns are 8%!**

The average returns are 15% per annum historically, and in favourable scenarios, returns of 18-20% have also been achieved.

Investment Period (years) |
% Positive |
Mean Returns (Annualized) |
Worst Seen Returns (Annualized) |
Bad Case Avg Returns (25th %ile Annualized) |
Median Returns (50th %ile Annualized) |
Good Case Avg Returns (75th %ile Annualized) |
Best Seen Returns (Annualized) |

1 year |
65% of all 1 year periods have had positive returns |
15.5% |
-53.0% |
-7.5% |
12.1% |
38.4% |
92.6% |

2 years |
74% of all 2 year periods have had positive returns |
14.4% |
-23.2% |
-0.5% |
13.4% |
28.1% |
58.5% |

3 years |
86% of all 3 year periods have had positive returns |
13.5% |
-15.5% |
2.8% |
9.5% |
22.6% |
58.8% |

4 years |
86% of all 4 year periods have had positive returns |
13.4% |
-7.9% |
3.8% |
10.3% |
19.1% |
47.1% |

5 years |
93% of all 5 year periods have had positive returns |
14.0% |
-7.0% |
5.4% |
11.2% |
20.3% |
46.4% |

6 years |
99% of all 6 year periods have had positive returns |
14.8% |
-2.1% |
7.5% |
12.2% |
21.3% |
37.1% |

7 years |
100% of all 7 year periods have had positive returns |
15.2% |
2.6% |
8.9% |
14.9% |
19.7% |
29.0% |

8 years |
100% of all 8 year periods have had positive returns |
15.2% |
3.2% |
10.6% |
15.3% |
19.1% |
27.1% |

9 years |
100% of all 9 year periods have had positive returns |
15.5% |
5.6% |
12.9% |
15.4% |
19.6% |
24.4% |

10 years |
100% of all 10 year periods have had positive returns |
15.4% |
8.0% |
13.6% |
15.7% |
17.9% |
20.7% |

**Caveat**

All the above analysis is based on how things have panned out in the past. The future can always be worse but as they say - history may not repeat but it sure does rhyme.

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