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Market volatility shouldn’t bother the long-term investors

America may or may not be into a recession, but we have definitely panicked. It is almost as if we have been gripped by severe paranoia. Is the market too stretched? Are stocks too overvalued at this level? Would the market fall further? How do we play this situation?

That in itself is the mistake - seeking advice on how to play this situation.

I suggest, let’s keep our eyes on the ball and not the situation. These questions, if at all, can only be answered by someone who can look into the future. Now, since we don’t have the ability, the next best thing is to use two tools that will help us tackle each delivery to the best of our ability. And these are:
a. The power of compounding, and
b. Long-term investing.

Albert Einstein called compounding the eighth wonder of the world. And just how smart he really was can be gauged by a story that really puts things in perspective.

This is a story in which a simpleton of a king lost a well-fought game of chess to an ordinary farmer. The king asked the farmer to choose his reward and all that the farmer asked for was one grain of wheat for the first square of the chess board, 2 grains for the second square, 4 grains for the third, 8 for the fourth and so on and so forth for all the 64 squares. The king was very happy for being let off rather lightly and readily granted the wish. The real snag came when he tried to settle the claim.

He needed 18,446,744,073,709,551,615 grains of wheat.

Now, isn’t that mind-boggling? Let me try to be more concrete. There are about 25,000 grains in 1 kg of wheat. The king required about 7,37,870 million tonnes (mt) of wheat to fulfill his obligation.

Now, here are some statistics for comparison. Our total national agricultural produce (wheat, rice, sugarcane, cotton, etc) in the year 2004 was around 200 mt. The required quantity of wheat is about 3,690 times this amount. Even all the wheat produced around the world since man learnt the art of cultivation will be far less than this quantity.

If the king had decided to settle this liability in cash, say at a super wholesale rate of Rs3.50 per kg, he would be required to pay Rs25,82,54,417 crore. This is over 2,000 times the Indian gross national product (GNP), which is the total value of all industrial and agricultural goods and services produced by India. What happened there was that the farmer used the power of compounding to his advantage. And such is the power that the king didn’t know what hit him. Realise that things were fine till the first few squares. It was only by the 10th square or so that it went out of hand. In other words, compounding, though the eighth wonder, only works if used over the long-term. In fact, long-term investing and compounding are two sides of the same coin.

Now, at this point, let’s get a perspective. The stock market has returned roughly 42% p.a. over the past five years. An average equity fund has returned 53% p.a. This means, Rs10,000 invested five years ago even in an averagely performing fund would have grown to over Rs80,000. Take out 20% and a long-term investor is still left with over six times his capital.

Will such returns be repeated in the future? I don’t know. Will such returns be NOT repeated in the future? Again, I don’t know.

But, I do know that it wasn’t smooth sailing all along. In 2000, we had the dotcom bust. Then there was September 11. Then Iraq and Afghanistan. Oil shocks. And how can we forget Kargil? Or India shining and the BJP losing? Each of these crises seemed unprecedented and the worst ever. But in time, we did recover. And all this while, quietly in the background, Kind Compounding was at work — those who had the faith have raked it in.

And now, we have the so called American recession and the collateral damage that it would bring in its wake. Over the next five years or so, the world would go thorugh more such calamities… What these would be, one doesn’t know, but surely the rules won’t change. Kind Compounding won’t stop and rest.

It is not as if I have not made the same mistakes. Rather, the intention is to share valuable lessons learnt the hard way. In fact, my first investment technically was a recurring deposit in a bank across the road. As a child and a student, it was my graduation of sorts from the piggy bank at home.

Breaking it open was an event that I have vivid and fond memories of. Working on the parents as only a child can, I managed to add Rs 200 to my princely capital of Rs 800 and was the delighted owner of a Rs1,000 bank deposit. Periodically adding to it gave me a special thrill as it meant a visit to the bank and acting all grown up.

Looking back, the RD proved to be a great investment. Though the capital was nothing that would make Donald Trump look over his shoulders, the entire process perhaps instilled a sense of savings discipline at an early age. Not to mention the fact that I could use the money to make my very first foray into the stock market… 100 shares in a well-known scrip was my first investment as a professional.

Actually, talking on this subject brings tears to my eyes, not on account of the nostalgia, but because as a novice investor, I made the mistake of getting out of the stock way too early… just as soon as I had made a few bucks. Had I held on, perhaps Donald would have had to look over his shoulders.

Those who don’t learn from their mistakes are condemned to repeat them. Therefore, I think I’ll just let King Compounding do the job for me. Efficiently and silently as it has been doing throughout history. In other words, I’ll not play the situation but every stock on its merit. I hope the long-term investor is listening.

sandeep.shanbhag@gmail.com