Equity investing needs long-term commitment

The BSE Sensex is a popular benchmark of equity market performance. The Sensex started its journey in 1979 with the base value of 100. As I write this article, its stands at 35,900 thereabout. It means that the Sensex has grown from 100 to 35,900; it has grown by 359 times over its lifetime of 39 years, compounding at a growth rate of over 16% per annum. This return has come after factoring few equity market scams, Kargil War, Iraq War, Internet bubble burst and the US sub-prime crisis.

Yet, when we talk to people, only a minority have good investing experiences to share. The majority of equity investors have lost their hard-earned money in the markets.

My curiosity got better of me; on digging deep to unearth the underlying reason why most people fail to create wealth. It is futile to blame the equity market. It wasn't difficult to infer that "It is not the equity markets that destroy wealth, our actions do."

Nobody wants to lose their money, yet most do. If I had to pick one root cause of our wealth destroying action – it would be "Lack of Financial Awareness & Literacy" and many a times it is the half-baked knowledge that proves more dangerous. The half-baked knowledge does not always stop at investors, it trespasses to few sets of inexperienced advisors.

Investing in the equity market without adequate knowledge of how the equity markets or equity fund works tantamount to "Experimenting". In my last article I had stated that it is not the product, but the ill-application of products that destroy capital.

When investing in equity markets / stocks, there are three important points to consider before you decide whether you should invest directly in equity shares yourself or you should take help of an equity fund manager:

• Research & access to market information
   
• The amount of money to be invested
   
• The time that you can allocate

People who have access to market information, research and have time and money can invest in equity stocks directly. The rest, which ideally would be the majority of the investor community, must invest through the equity fund route.

Let me share few simple thoughts of participating in equity markets and winning it.

Mutual fund helps you get the game of probability right. Rolling returns of the equity index, say Nifty, provide an important clue of simplifying your equity investment strategy.

Return range – The annualised return range for Nifty over the last many years, for different time horizon of investment are as follows.

• 1-Year period – Negative of (-) 53% to +85%
   
• 3-Years period – 1% to 70%
   
• 5-Years period – 1% to 33%
   
• 10-Years period – 11% to 36%

Risk probabilities – I have assumed negative returns and returns lower than fixed deposits as the opportunity risk.

The rolling return for an investment horizon of one year suggests a probability of 60% of positive returns and 40% time we will have either negative or lower returns than fixed deposit. The probability increases to 75% for a time horizon of three years rolling period; 88% for a five-years period and almost 99% if the time horizon is increased to 10 years.

The above probability holds good for the broad index or diversified equity MFs. It does not hold good for a direct individual stock. This is because the risk of a diversified MF or Index is much lower than that of an individual stock. If you visualise any 10 years period and evaluate the BSE Sensex it would be hard to find a period that hasn't positively delivered the return. Let us take two cases – as we talk in December 2018, the BSE Sensex is 35900 and if we go back to December 2008 we would be closer to 9,500 (this is post the sub-prime crises). The biggest crash happened post the sub-prime crisis and market tanked to its lowest level of 8,900 by March 2009. If you again go back 10 years from there and look at the market in March 1999, the Sensex would be closer to 3,300 levels.

Optimising return and mitigating risk – Investing in equity MF for a longer time horizon not only helps to optimise investment returns but also significantly reduces the risk of equity investing.

To benefit from equity fund investing one has to treat this as a marriage – a long-term faithful commitment and relationship. Flirting with equity funds can be harmful for your financial health.

The writer is founder & CEO, Fincart