Stock markets are dynamic places where countless people can trade in various financial securities at the same time from anywhere in the world. Millions of trade take place every second. Some people offload their shares while others buy it at the same time. The primary aim of investing in equities is wealth creation. One buys a particular stock with the expectation of increasing the value of the initial investment. While investing in the stock market, the focus remains on the potential returns of a company’s shares. But another important aspect of market returns is often missed by many people. The time duration of the investment. Any return without considering the time duration of the investment is meaningless. A 10% return on an investment in a year is a sought-after proposition, but a 10% return in 5 years may not be desirable. When one talks about the time dimension of an investment, the holding period becomes important.
What is holding period
The holding period is simply the amount of time one remains invested in a particular asset. It is the time between the purchase and the sale of a security. In the case of long positions, the holding period is the time between purchase and sale of an asset, while in the case of short positions the holding period is the time between the security is bought by the seller and it is delivered back to the lender to close the position.
Importance of holding period
The holding period is important primarily for two major reasons–returns and taxation. The tax levied on certain assets is calculated on the basis of the duration of the investment. If the asset is disposed-off before a certain threshold and if you sell the asset at a profit, it attracts short term capital gains tax. On the other hand, assets held for a long time attract long term capital gains tax. Similarly, if you suffer a loss on your investment, you may also be allowed to set off the loss against future gains in specific conditions.
Holding period is also used while calculating returns on investments. An equity investment pays in multiple ways. The value of the initial investment grows and simultaneously many companies also pay a dividend. When you calculate the holding period returns, you take into consideration all the income from the investment like dividend along with the increase in the value of the investment. Holding period returns help in comparing various investments with different durations.
How to calculate holding period?
It is common to see stock recommendations with a clearly defined minimum holding period. All seasoned investors consider the stock holding period while calculating overall returns. Holding period is the time between the day after a stock is bought till the day the stock is sold. For example, Mohan buys shares of XYZ on November 10 and sells it on December 21. The holding period for the investment was November 11 to December 21. Once you get the holding period, you can also calculate the holding period return. To get the holding period returns, use the formula, [Income + (EOPV – IV)]/IV, where EOPV is the end of period value and IV is the initial value. The importance of holding periods in calculating returns is clear. Let us take a detailed look at the impact of holding period on taxation of gains or losses.
Capital gains is any profit or gain accrued from the sale of a ‘capital asset’. The profit from the sale is considered as ‘income’ for the purpose of taxation and hence one has to pay tax on the profit. Capital gains can be of two types–short term and long term. While there are various capital assets like land, building, house property, patent, etc, let us focus only on equity shares. The holding period for the classification of short term and long term capital gains varies according to the holding period. In the case of equity shares, the asset is considered to be a short term asset if it is held for less than 12 months. If a stock is held for more than a year, it is considered to be a long term capital asset and the profit or loss from the sale is taxed accordingly. The long term capital gains tax on securities is 10% over and above Rs 1 lakh. It essentially means that the holding period of a stock is more than 12 months and you have gained less than Rs 1 lakh on the investment, you will not have to pay any tax. Short term capital gains are taxed at 15% if securities transaction tax is applicable. If the securities transaction tax is not applicable, the short term capital gains are added to the income and the taxpayer is taxed according to the income slab.
Along with taxation and returns, holding period gains significance if the company announces a dividend. When a company announces dividend, there is a minimum holding period requirement. A shareholder is eligible to receive stock dividend only if he/she has held the stock for a certain duration of time. The minimum holding period is checked before paying the dividend. Holding period provides a perspective to stock investments. Without a holding period, comparing the returns of two assets would be difficult. Holding period provides a comprehensive view of the returns generated by an equity investment.