The randomness of stock market returns can be illustrated by long time-series. In the 20 years since January 1999, the Nifty had seven years of net losses. It also had three big years when it gained over 50 per cent. In 10 years, it gained, with annual returns somewhere between 1-15 per cent. In January 1999, the Nifty was at trading around 900. It is now in the 10,750 range. This means the compounded return for this period is around 13.25 per cent.
The compounded annual rate of growth, or CAGR is more than acceptable since the real returns would have exceeded inflation comfortably. It’s unlike that any other asset-class would have fetched higher returns across that two-decade period. But the return is not consistent. Something like 40 per cent of the time, the return is either negative, or lower than inflation. In 11 of those years, fixed deposits beat equities.
This data explains why it’s sensible to park a large chunk of your savings in equity — it will give you the best returns over the long-term. This data also explains why you should not put everything in equities: there are no guarantees about returns in the shorter-term. If you need money for an emergency or in order to make some sort of regular payment, you can’t rely on cashing in on an equity investment.
The bull-run of the past few years has led to an interesting change in the demographics of investors. More retail investments have come into the market — indeed, strong mutual fund inflows have kept the market afloat. But this also means that there are a large number of first-time investors who had never suffered serious losses until 2018.
In behavioural terms, this means there are a lot of investors who frankly don’t know their own risk-appetites. When investments keep growing at a fast clip, it’s easy to over-allocate to equity, and also to be aggressive in picking growth investments.
The last calendar year saw poor returns. The Nifty returns were nominally positive but barely kept ahead of inflation. Fixed Deposits outperformed. Small-caps and Mid-caps gave negative returns, with small caps losing over 20 per cent.
This sort of loss-making period is the acid test when investors discover what their risk appetite really is. Can you live with 20 per cent capital erosion? Can you live with 30 per cent? There are years when a decent equity portfolio could lose 50 per cent. Can you live with that?
The next six months could be fairly bearish. Historically, the lead-up to a general election tends to be excessively volatile and big losses are perfectly possible. It is a good time to take stock of your equity portfolio.
Some equity investors will cut off their investments totally if the market gets too volatile. Don’t do that. If you wish to reduce volatility, shift your weight from small caps to large caps because large caps lose less in downturns (they also gain less in bull markets).
Here are a few more suggestions to help ride out volatility. First, take an overview of your financial needs during this period, and maybe, for the entire year. Make sure that those needs can be fulfilled without touching your equity investments. If you need to lighten up the equity component of your portfolio to ensure that you will have that cash on hand, do so. Park it in short-term or medium term debt — either in debt mutual or in fixed deposits. If interest rates do fall, the debt mutual will make much better returns than fixed deposits.
After that, be prepared to committing to any systematic investment plans you hold. Be prepared to commit more, if there are big losses in April and May. Gamblers call this a Martingale strategy. Unlike roulette, where a loss is a loss, in equity investments, buying more stock at lower prices leads to lower averaged cost. An eventual market recovery means better returns.
You may note various surveys that suggest a coalition government will lead to bad economics. This is a common belief. It is also rubbish. The best economic governance has been delivered by coalitions. The very best decisions, were taken in 1991 and 1999 by coalitions that did not know if they would survive from day to day. If a coalition comes to power, the market could see a powerful recovery.