Why a boring investment strategy works in the long run
When you are too obsessed with finer details, you sometimes miss the big picture; which could be much better than what it looks like when seen with a microscope.
Remember the story of blind men made to feel different parts of an elephant and asked what they were touching. Each one of them come up with a different answer — pillar (for legs), hand fan (for ears), rope (for tail), and so on — which may be correct if seen separately, but none of them could tell they were touching an elephant.
Similarly, in the stock market, investors’ narrow focus on short-term price movements and the factors leading to these movements often make them ignore the broader, long-term prospects. While a slowdown in China, higher than expected inflation, or slow exports growth may be a cause of concern in the short-term for equity investors, these situations would not continue forever. Things do change — for better or worse — as in life, so in the economy and stock markets.
Indian equity markets have seen a lot of bad times in recent past, but things are changing. Just a couple of years ago, the country was battling with double-digit consumer inflation, high interest rates and slow GDP growth rate. Today, the inflation is below 6 per cent, GDP growth is comfortably above 6 per cent (as per earlier GDP calculations), and RBI has cut interest rates twice since the beginning of the year.
Despite all these, equity markets have hit some stumbling blocks due to some short-term global and domestic factors. The National Stock Exchange’s Nifty index after hitting 9,000 in March this year, collapsed below 8,000 levels in June, only to recover 500 points by August 14. For a developing country such as India, the prospects of positives neutralising the impact of negatives in the long run is much higher. Therefore, investors would have to take into stride the intermittent volatility and stay invested over a long term to make money in the equity markets.
Volatility: Rhymes and Reasons
Price volatility is an inherent nature of any market, where there are many buyers and sellers. Each participant has a different target and a time horizon for which she is in the market. Once that target is met, she would exit from the market. There are short-term players, who invest for a day, a week, a month or for a longer period. Some investors come and go at regular intervals. Because there are so many investors, and all have their own way of measuring the impact of a certain event (in or outside the country) on the equity markets or a company stock, they keep re-valuing an index or a stock at regular interval. If the numbers of investors who are positive about equity markets of a particular country or on the prospect of a particular company are more than those who have negative views, the stock or the equity market of the country would continue to grow in the long term, despite the intermittent volatility. While volatility rattles investors, a long period of sideways movement (accompanied by intermittent volatility) also makes investors impatient. The impatience stems largely from unrealistic expectations from equity markets.
Investors expect equity markets to churn out 25-30 per cent returns every year; after all they are investing in the most risky asset class. Such high expectations are benchmarked to the best years of equity markets. There were times between 2004 and 2007, when equity markets delivered 25-30 per cent returns every year. However, Indian equity markets have generated 16-17 per cent annual return in long term (past 30 years). Even a 17 per cent return is stupendous given that bank fixed deposits have typically give at 9-10 per cent return over the same time.
Why boRing is best
Often, I have heard investors saying they prefer investing in direct equities to investing in mutual funds because there is no “fun” in investing in mutual funds. It gives them a kick to find a “cheap” stock (they often end up buying penny stocks of companies, with little-known promoters running their companies from a garage), and wait for the stocks to treble or quadruple in no times. Sometimes, the wait can be forever. Markets reward stocks that have good future prospects, have competitive advantage and good corporate governance. These stocks, more often than not, come at a premium valuation — which cannot be gauged by the price of the stock. Remember, a stock priced at Rs 250 can be more expensive than one priced at Rs 1,200. Many retail investors do not know this basic difference.
Without proper knowhow and resources, many investors plunge into stock markets simply because it gives them the kick, and end up incurring huge losses. Equity markets reward only those investors who have the patience and discipline to stay invested for long terms, without bothering too much about sudden dips and getting excited about sudden runups in the equity markets. Investing regularly in equity mutual funds, which are managed by trained professionals who have at their disposal a number of analysts, sector specialists and tracking mechanism, is the best way to invest in the long-term. They are driven by laid-out processes and methods of picking and dropping stocks, and react to events and policy changes with more alacrity than a retail investor would do himself.
Systematic investment plans, or SIPs, are said to be a no-brainer (and therefore boring) since they do away with the need to time the market, and the regularity of investments help the investor capture all market conditions. An SIP even in a mediocre fund such as LIC Nomura Growth Fund starting on January 1, 2008, (the year markets saw the worst ever fall), would have given 15.15 per cent annual return as on August 14, 2015. If only investors remain indifferent to all the “noises” in the market, and continue investing in a regular and disciplined manner, they can reap the benefits of equity investments in the long term. No analyst worth his salt can predict market movements correctly all the time. Therefore, stop getting swayed by their articulation on television channels or newspapers and just follow the right script, which can be low on excitements but high on delivery.