Frequently for the common man, the Sensex, and by extension, stock markets, are either something to be dabbled in after they have been in the news thanks to strong recent performances, or — fresh from yet another bust — a gambler’s den.
But even as the market has gyrated up and down session after session, entered into phases of exuberance and pessimism, it has steadily trundled upward over the long term.
Since 1986, when the Sensex was first published, it stood at roughly 550 (with a base value of 100 dating back to 1979). Today, it stands at roughly 28,000, implying a gain of 50 times over 30 years. In compounded terms, that is a return of 14 percent, not including roughly 2 percent dividend .
Those with good financial sense or a CAGR calculator would know those returns almost always beat or match any investment in Indians’ favourite asset classes: property or gold.
Still, despite producing vastly superior returns, investments into equity remain the preferred choice of a few. As of last year, just 2 percent of India’s household savings was invested in equity. Foreign investors owned 70 percent of the shares floating in the market. Efforts by the EPF office to allocate some more of its multi-billion-dollar worth corpus in stocks is met with resistance.
Why investors (mostly) don’t make great returns from stocks
By their very nature, making direct purchases of stocks is a tough act. Still, investors tend to equate the ease with which they can purchase shares to the ease they hope they will have in making strong returns.
The biggest mistake they make is failing to understand the difference between speculation and investing.
So stock purchases are made because they have risen a lot or fallen a lot, because an expert recommended it on TV or because they got a ‘tip’ from someone who sounds knowledgeable about the markets but isn’t.
A thumb rule — if you do not understand a business well enough to forecast its long-term earnings potential, you should not buy its stock — would likely filter out a majority of individual investors. Jim Rogers has a simpler rule. If you haven’t read a company’s annual report, don’t buy it.
If you don’t truly understand a company well, you simply will not make money in it, except by chance. As Rakesh Jhunjhunwala says when asked for stock recommendations, “you cannot make money from borrowed wisdom”.
Then there is another breed of investors that thinks it is easy to move in and out of markets or stocks using charts, gut feeling or a combination of the two.
When asked why they wouldn’t want to buy the index and do nothing for years, they believe they can do better — without realizing that it is simply incredibly difficult to beat the market’s long-term’s return (about 15 percent), over, well, the long term.
A stock broker once told me that if I invested with him, I could look at making 40 percent returns in a year. It was lost upon him that 40 percent annual returns consistently produced over 40 years would turn him, if he started with Rs 1 lakh, into a Forbes billionnaire.
Finally, there is a genuine confusion about what comprises the long term. The holding period for the average mutual fund investor was under 2 years , according to a report last year. For active stock investors, it is likely less, possibly in months.
Part of the reason why holding periods are less is because flows into the stock market tends to be bunched up. Inflows are most when the markets are at a high and when it could be an inappropriate time to buy. Investors flee equities after they’ve faced a loss, thanks to the inopportune time of their entry.
The fact that many investors do not have the emotional strength to stomach strong moves in the stock market flies in the face of long-term data that suggests that as holding period for a market benchmark such as Sensex increases, not only does the possibility of a loss goes down, the chances of beating inflation steadily rise. (The table below details the Sensex value at the start of every year since 1979 and outlines returns for one year, three years, five years and so on hence.)
So even if you invested in Sensex in 1992 at the height of the Harshad Mehta scam, when the market had gone up six times in three years but chose to stay on for 15 years instead of exiting immediately with a loss, you’d still have come out with a 7.7 percent return, enough to beat inflation.
Put simply, if investors were as patient with the stock market as they are with a typical property investment, they are likely better off investing in the stock market.