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The problems of long-run data results and medium-term living

It’s confusing for retail investors to constantly come upon research that give conflicting results.
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First Published: Tue, Feb 19 2013. 07 16 PM IST
Shyamal Banerjee/Mint
Shyamal Banerjee/Mint
I like to talk about the efficacy of having equity in the portfolio because that is an asset class, I have been led to believe, which gives an inflation-plus return. But equity’s image as a super asset class beating the stuffing out of inflation has been under attack for a long time, specially so since 2008. Then last week a colleague sent across some disturbing news. The Economist has a story (http://econ.st/VqMcNA) which says that global bonds have outperformed equities since the start of the 1980s. The story is based on a book, “Triumph of the Optimists: 101 Years of Global Investment Returns,” written by London Business School professors Elroy Dimson, Paul Marsh and Mike Staunton. The colleague’s unasked question: “But you said…”
This takes me back to the time when another deeply held belief of mine was shattered into tiny bits. It was a year ago, when my behavioural finance professor Robert Shiller put up a slide that said the real return on residential housing in the US from 1890 all the way to about 1990 was almost zero. And that the super returns in the 20 years after that were a bubble that is still deflating. So investment in houses gave nothing back post inflation. But that’s not true, I remember thinking. I know people who made money from housing in the US and in India. Look at all the SUVs running over people in India and you’ll see the scions of real estate tycoons (could even be brokers striking it rich) who’ve come by masses of quick money on the strength of real estate prices soaring in India.
Then there is research that gold is a hedge against inflation but does not work too well for capital appreciation. Tell that to the housewives who’ve had the last laugh over the last 10 years in India. My cousin, who now runs a tiny online clothes gig, has purchased part of the business recently through her buying gold in small tranches over the last few years. But I know that real data shows that the historical return of gold is nowhere near the returns we saw in the last few years. And that what has happened with her is actually a blip in gold prices.
The best of the breed tell us that nothing works to beat inflation over the very long term. Keynes was correct, we’re so totally dead in the long run. How do we deal with this? It is bewildering and scary for retail investors to constantly come upon research and data that give conflicting results. For people who are not fully engaged with the markets, the asset class choice becomes tougher and tougher. And they do the most sensible thing when faced with too much choice or too many alternate theories. They freeze. And run to the tried and tested financial product -- gold, real estate and fixed deposits. But is there a way to navigate this long-term-we’re-dead truth and the medium-term blips in asset prices that we see around us?
As retail investors we need to understand that no asset class gives sustained supernormal returns over the very long term and looking at point-to-point returns reinforces this point. But slice the data into shorter time periods and you see equities outperform in blocks of years. As does gold. And real estate and bonds. What do we do, time the markets? No. We can’t. We’re not fully invested in tracking global movements of assets and have a day job to do and the dog to play with thereafter. The only rational thing that works for me is the financial planning approach that looks at a basket of assets rather than an all-or-nothing approach. It does mean making rough rules around how much of each asset you are happy with in your portfolio. So that when that ratio gets out of whack, you do rebalance the portfolio. Rebalancing is to sell the asset class that has run up terribly and buying one that is underperforming.
Impossible to do emotionally, of course, but that’s the advice. In fact, the theory of diversification was tested by my colleague Lisa Pallavi Barbora (read the story here: http://bit.ly/ZomUmR), who looked at blocks of years and then looked at portfolio return. She found that there are periods of supernormal growth in the value of equities and that is balanced out by sagging returns. A balanced portfolio managed to ride out most of the storms and delivered a middle of the road portfolio return. Does that mean buying and selling? Well, if you are able to do it, and most of us can’t. But a balanced fund does that wonderfully, with the fund manager taking the call. Look at the Mint50 funds here http://bit.ly/XhS6RQ to consider some balanced funds.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com
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First Published: Tue, Feb 19 2013. 07 16 PM IST