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Market returns aren’t linear, but long-term investors stand to gain
Regular readers of this column would know that I am an evangelist of long-term investing.
Actually, in my dictionary, ‘long-term investing’ is euphemism for a combination of the powerful twin forces of compound interest and time. Compound interest in solitude means little and time without the company of compound interest is equally meaningless. If you don’t believe me, ask all those who have invested in endowment and money back insurance policies. Even after a holding period of 15 or 20 years, their returns remain poor since the bonus is not compounded.
That said, our basic problem seems to be that inflation is where gross domestic product (GDP) growth should be and GDP growth rate is perhaps where inflation should be. The consequent impact on stock markets and mutual funds has been acute. Both stock prices and NAVs have come off over 30% (in some cases much more) from their all-time highs.
But, for a moment, let’s consider if things are really all that bad. As human beings, we tend to focus on the immediate past — simply because it is the immediate past that is the freshest in memory. And since this immediate past (January 2008 onwards) hasn’t been too kind on our investments, we have become consumed by self-doubt and in some cases even panic.
This tendency of looking at the immediate past is also known as the near-term perspective. A long-term investor would think a bit differently. While being fully aware of the recent happenings, he would also keep his eye on the big picture. While being mindful of the fact that NAVs have fallen by over 30%, he would also know that an SIP of Rs 10,000 in a well-managed diversified equity fund like say Reliance Growth over the past 10 years would have grown to over Rs 1 crore, thereby earning a net tax-free return of 35% p.a.
However, this 35% p.a. hasn’t been earned linearly every year, like say the Public Provident Fund (PPF) account, which would earn 8% every year. In the case of PPF, the initial investment of Rs 100 would become Rs 108 in one year, Rs 116.64 in the next year, Rs 126 in the third year and so on. However, in the case of the Reliance fund, the return has not been earned linearly. In other words, in the fund, Rs 100 may not have grown to Rs 135 in the first year, Rs 182 in the second year and so on. Instead, the value (NAV) would have fallen or risen as per market sentiment. However, when you examine point to point, you would have earned a return of 35% p.a.
To further emphasise the benefit of long-term investing, let me share with you a very interesting piece of analysis I came across in The Wise Investor, the monthly newsletter from Sundaram BNP Paribas Asset Management (see chart). It shows the value of Re 1 remaining invested at all times in the Sensex and what it would be worth if you missed the best days in the market. The numbers tell the tale. If you had stayed invested in the Sensex since launch, Re 1 would be worth Rs 161. If you had missed the best 10 days, the value would be Rs 62, and this number declines significantly to Rs 10, if you had missed the best 40 days.
Consider the significance of this for a moment. The Sensex was launched in 1986. We are in 2008 today. That makes it roughly 8,000 days since the launch of the benchmark index. And of those 8,000 days, what makes the difference between a successful investor and an also-ran is 40 days — 40 days out of 8,000!
The key, as we can see, is to stay invested — for the simple reason that we do not know which would be the best days in the market. Of course, if you could sell only during the bad days and remain invested only during the good days, you would make more money.
But that would mean predicting the future, which is impossible. So, the next logical thing to do would be to stay invested such that the good days are automatically taken care of. To put it differently, in the stock markets, patience is genius.