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Equity: the long-term story

No one knows where the markets are headed. Just be smart and stick to your plan

There are always sufficient reasons not to invest in equity. You don’t even have to think too hard. After all, the world always has a crisis. Or valuations are way too high. If that is not the case, then the economy is in doldrums. However, there is sufficient empirical evidence indicating that equity, as an asset class, has an impressive track record in terms of performance.

Way back in 1 October 1991, the Sensex closed at 1,858.45. On 1 October 2013, it closed at 19,517.15. During these 23 years, everything was not that rosy.

In fact, the stock market went through some fairly dramatic phases: Persian Gulf crisis (1990), global recession (1992), Asian financial crisis (1997), dotcom meltdown (2000), the India-Pakistan stand-off that brought both sides close to war (2001), the 9/11 terrorist attacks on the Twin Towers in New York (2001), war in Iraq (2003), global financial crisis (2008) and the eruption of the European debt debacle (2010). Not to mention the weak macroeconomic fundamentals that ingrained fear even in the most diehard equity investors this year.

Despite the turmoil that the market has gone through, the Sensex numbers clearly indicate in no uncertain terms that investing in equity is the best way to beat inflation and build wealth. The tax advantage only adds to its appeal.

Take into account the transactional ease, liquidity and the low investment threshold and it is obvious that few asset classes come close in these respect.

A very vocal and vociferous argument against equity is that it is a volatile asset class. The investor is not only exposed to fluctuations in prices but also exposed to the risk of loss of invested capital. While there is no denying that what investors fail to realize is that volatility only works against those who flee from equity at the slightest sign of turmoil.

At the Morningstar Investment Conference 2013 held in October in Mumbai, Scott Burns, director-fund research, Morningstar, made a very interesting observation with regards to investor behaviour. He explained that investors feel the pain of a loss of investment twice as much as they feel the pleasure of the gain. This is the reason they flee from equity the moment the ride gets turbulent. Instead of riding through the storm, they opt out with losses. This is detrimental to an investor’s portfolio and a prime cause for disenchantment with equity.

On the other hand, if we look at the same period mentioned above and consider the case of an investor who chose to ride the storm, it is clear that the volatility did not hinder his returns.

Let’s say an investor invested 10,000 in the Sensex every October over the 22-year period 1991 to 2012. An investment of a meagre 2.20 lakh distributed over 22 years causing no stress to the investor’s wallet would have been valued at 8,67,310 on 1 October 2013. A tax-free compounded annual growth rate of 11.30%.

Equity cannot be ignored by any long-term investor who needs to beat inflation and accumulate wealth. And, if you invest systematically, the volatility will not affect you. If you do not, you are susceptible to emotional upheavals with every market movement which will hinder your returns.

A few months ago there was a pall of gloom across global financial markets with talks of tapering quantitative easing by the US Federal Reserve. This had an overwhelming impact on the Indian markets which were already reeling under pressure due to the slowdown in the economy.

Today, the Sensex is flirting with record high levels. Those who pulled out on the back of bleak news would have missed out on this current rally. And those who stayed away during the downturn would have missed out on the opportunity to buy stocks at dirt cheap valuations.

It would be quite hard to identify what changed over the last couple of months. Is it just perception? Is the Indian economy really back on track? Is the worst in terms of low growth behind us?

There is optimism that the market will move ahead on the back of strong liquidity flows from foreign institutional investors, the lowering of crude prices, gradually falling current account deficit and the halt of the rupee’s decline.

Frankly, no one knows where the markets are headed. Just be smart and stick to your plan. Eventually, investments in good businesses will reap rewards and you will definitely emerge as a winner.

Aditya Agarwal is managing director, Morningstar India.

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