Sensex, the country's most recognized stock market index alongside the Nifty, completes thirty
years of existence this year and exchange BSE will obviously want to do
much to highlight the successful returns the barometer has posted over
the years.
Frequently for the common man, the Sensex, and by extension, stock
markets, are either something to be dabbled in after they have been in
the news thanks to strong recent performances, or -- fresh from yet
another bust -- a gambler's den.
But even as the market has gyrated up and down session after session,
entered into phases of exuberance and pessimism, it has steadily
trundled upward over the long term.
Since 1986, when the Sensex was first published, it stood at roughly 550
(with a base value of 100 dating back to 1979). Today, it stands at
roughly 28,000, implying a gain of 50 times over 30 years. In compounded
terms, that is a return of 14 percent, not including roughly 2 percent
dividend .
Those with good financial sense or a CAGR calculator would know those
returns almost always beat or match any investment in Indians' favourite
asset classes: property or gold.
Still, despite producing vastly superior returns, investments into
equity remain the preferred choice of a few. As of last year, just 2
percent of India's household savings was invested in equity. Foreign
investors owned 70 percent of the shares floating in the market. Efforts
by the EPF office to allocate some more of its multi-billion-dollar
worth corpus in stocks is met with resistance.
Why investors (mostly) don't make great returns from stocks
By their very nature, making direct purchases of stocks is a tough act.
Still, investors tend to equate the ease with which they can purchase
shares to the ease they hope they will have in making strong returns.
The biggest mistake they make is failing to understand the difference
between speculation and investing.
So stock purchases are made because they have risen a lot or fallen a
lot, because an expert recommended it on TV or because they got a 'tip'
from someone who sounds knowledgeable about the markets but isn't.
A thumb rule -- if you do not understand a business well enough to
forecast its long-term earnings potential, you should not buy its stock
-- would likely filter out a majority of individual investors. Jim
Rogers has a simpler rule. If you haven't read a company's annual
report, don't buy it.
If you don't truly understand a company well, you simply will not make
money in it, except by chance. As Rakesh Jhunjhunwala says when asked
for stock recommendations, "you cannot make money from borrowed wisdom".
Then there is another breed of investors that thinks it is easy to move
in and out of markets or stocks using charts, gut feeling or a
combination of the two.
When asked why they wouldn't want to buy the index and do nothing for
years, they believe they can do better -- without realizing that it is
simply incredibly difficult to beat the market's long-term's return
(about 15 percent), over, well, the long term.
A stock broker once told me that if I invested with him, I could look at
making 40 percent returns in a year. It was lost upon him that 40
percent annual returns consistently produced over 40 years would turn
him, if he started with Rs 1 lakh, into a Forbes billionnaire.
Finally, there is a genuine confusion about what comprises the long
term. The holding period for the average mutual fund investor was under 2
years , according to a report last year. For active stock investors, it
is likely less, possibly in months.
Part of the reason why holding periods are less is because flows into
the stock market tends to be bunched up. Inflows are most when the
markets are at a high and when it could be an inappropriate time to buy.
Investors flee equities after they've faced a loss, thanks to the
inopportune time of their entry.
The fact that many investors do not have the emotional strength to
stomach strong moves in the stock market flies in the face of long-term
data that suggests that as holding period for a market benchmark such as
Sensex increases, not only does the possibility of a loss goes down,
the chances of beating inflation steadily rise. (The table below details
the Sensex value at the start of every year since 1979 and outlines
returns for one year, three years, five years and so on hence.)
So even if you invested in Sensex in 1992 at the height of the Harshad
Mehta scam, when the market had gone up six times in three years but
chose to stay on for 15 years instead of exiting immediately with a
loss, you'd still have come out with a 7.7 percent return, enough to
beat inflation.
Put simply, if investors were as patient with the stock market as they
are with a typical property investment, they are likely better off
investing in the stock market.
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