Why 3-Year Return Is Higher Than 5 Years? Explain With Example

online investments

As you navigate the world of investments, you have likely seen returns expressed over different timeframes. A common sight is the comparison between 3-year and 5-year returns, sometimes with the former appearing surprisingly higher.

This can be confusing, particularly if you are told that long-term offline or online investments offer better returns. So, why does this happen, and should you prioritise 3-year returns over 5-year ones?

Market volatility and short-term fluctuations

Short-term periods, like 3 years, can be likened to thrilling sections with steep climbs and sharp descents. Market sentiments and external factors heavily influence these rapid fluctuations, potentially leading to impressive returns in a bull run or significant losses during a downturn.

Here’s an example: Consider a small-cap fund performing exceptionally well during a bullish 3-year period, generating a return of 30%. However, the subsequent 2 years could witness a market correction, pulling the overall 5-year return down to a more moderate 15%.

In contrast, the 5-year timeframe acts as a smoother ride, encompassing both the highs and lows. It provides a more holistic picture of the investment’s performance, averaging out the short-term volatility and presenting a more realistic long-term trend.

Power of compounding: A long-term advantage

While seemingly surprising, a higher 3-year return doesn’t necessarily invalidate the value of long-term investing. The principle of power of compounding amplifies your returns over extended periods, making even moderate annual gains into wealth over time.

Let’s illustrate this with a simple example:

Scenario 1: Invest Rs. 10,000 in a fund with a consistent 10% annual return for 5 years. Your final value would be Rs. 16,105.

Scenario 2: Invest Rs. 10,000 in a fund with a 20% return in the first 3 years followed by a 5% return in the next 2 years. Your final value would be Rs. 16,786.

Finding the right perspective: Choosing your timeframe

So, which timeframe wins: 3 years or 5 years? The answer depends on your investment goals. If you are seeking short-term gains or comparing funds for a specific period, the 3-year return offers valuable insights. However, for long-term wealth creation, the 5-year (or even 10-year) return provides a more comprehensive and realistic picture of a fund’s ability to weather market turbulence and generate consistent returns.

Beyond the numbers: Other factors to consider

While timeframes play a crucial role, they are not the only storytellers. When evaluating a fund, consider these additional factors:

Fund manager expertise: A skilled manager can navigate market cycles and adapt strategies to deliver consistent returns.

Investment style: Does the fund align with your risk tolerance and investment goals?

Expense ratio: Lower fees translate to higher returns for you.

Risk profile: Understand the fund’s volatility and how it aligns with your risk appetite.

By understanding the difference between 3-year and 5-year returns, you can make informed financial planning, and navigate the Indian market with confidence. Remember, patience and a long-term perspective are your keys to unlocking sustainable wealth creation.