This is that time of the year when the knives are out for equity. While the Left makes political cakes out of ashes in the market, there is genuine confusion among lay readers and investors. Writes Dr Viraj Shah of Ahmedabad: “The Dow Jones was around 66 a century back and today it is around 8,500, giving a CAGR (compounded annual growth rate) of only 5 per cent. The Nikkei was 7,162 in 1982 and was at same level after 26 years a week back, which means negative returns taking inflation into account. Then why it is said that equity has given the best returns of around 12 per cent over long periods? I think that 100 years or 26 years are long enough investing periods. Is it true that equity as an asset class has given maximum returns over the long term? This is an utterly confusing situation.”
Valid question. But we need to look at point-to-point comparisons very carefully. By choosing dates I can either get the market to perform very well or very badly. Simply pick a year in which markets have done badly and compare to a year of stock boom to show performance or the reverse. One way out of this statistical bias is to use what are called ‘rolling returns’. Let’s see what you would have earned as return if you had bought the Sensex on any day from 3 April 1979 to 7 November 2008 and held that investment for a year. Across 29 years, your maximum return would have been a fantastic 265 per cent and worst loss 56 per cent. Now, what if you held on for two years? Or three? As the number of years that the investment is held goes up, the gap between the minimum and maximum return goes down, or, in jargon, the volatility reduces. After five years, the minimum return (or loss) is minus 8 per cent and the maximum return 56 per cent. After 10 years, you lose 3 per cent but gain 35 per cent. At a holding period of 14 years, the minimum return is 5 per cent, the maximum is 29 per cent. This means that if you held the Sensex over any 14-year period from 1979 till 2008, the minimum return would have been 5 per cent, or you would not have lost money. And over a 25-year period, the average return is 14 per cent.
But you cannot eat average return, you say. Sure, you cannot. Therefore, you have this wonderful tool called rebalancing your portfolio that allows you to book profits of the asset class that is rising and invest in the class that is not. In the research period, there have been years of super-normal returns. Those are the years in which to book profits and move money to the safer asset class of debt. Keeping your overall asset allocation in mind, the move should be from debt to equity when the reverse happens. Long-term investing will work only if you follow the rules, just as your car will move forward only if you learn how to drive. If you choose not to learn driving, it is best to hire a driver, or an asset-allocating lifecycle fund that will do the rebalancing for you automatically. So, yes, equity works, but we need to follow the rules.
Editor, Outlook Money____
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