Bringing up your Investments...A parent's perspective
As the parent of two teens I have seen them evolve over time. From the joys of the new born who holds you tight it is quite an eventful journey till they get to adulthood and spread their wings. Having just been to my elder child’s graduation (12th standard) and with adulthood now just a few days away it has been quite a satisfying journey. It does get bumpy at times with a whole range of moods- the terrible twos, the feisty fives, the tender tens, the troublesome teens, sweet sixteen and so on. And even as they hit adulthood, you can’t stop being a parent. You can’t stop worrying. Their careers, the jobs of the future, the country, cultural wars- just so much going on.
So why am I reminiscing so much in a column about investing? Because the moods you go through during the journey as the parent of a child are in some way quite similar to the mood swings and volatility you should expect during your investing journey. Today it is easy to look back at how the equity markets have performed over the many years with satisfaction and nostalgia. The returns at at 9.5% pa over 10 years, 18.8%pa over 15 years or 13.3%pa over 20 years (Nifty TRI) look quite attractive. And if you had invested with a fund that has managed to add Alpha to that then your returns would look better to that extent. Alpha is after all what we fund managers are supposed to deliver- the incremental returns above that of the benchmark Index -which you could mimic by investing in an index fund or ETF.
But what these longer term returns hide is the bumpy ride you are likely to experience over the course of the journey to your destination. Much like all those tough and trying times you experienced while your child grows up. I am sure you are all familiar with the Nifty index-that 50 stock index that has chronicled our times in the market since 1995. From January 1995 till March 31 3018 it has delivered a return of 11.1% pa (Nifty TRI), beating rather handsomely the returns you could earn from bank deposits. It does not achieve this in the linear plodding fashion that you associate with bank deposits which accrue interest on a regular basis. The returns in equity markets go through a pattern which a looks a bit like start- go-rise-fall-stop-go-rise…a pattern that is not predictable and yet is repetitive. It cannot be predicted though you will meet many a fine soothsayer and crystal ball gazer who suggest that they know exactly how it is all going to play out. Much like the Bollywood happy ending you can expect to achieve good results over the long term but expect bothhappy songs and sad songs along your journey. And this journey unlike a Bollywood move has no end – it will play on and on and will often repeat itself.
Volatility has always been a part of the Journey of the Nifty. Much like the trials and tribulations you can expect as a parent. Take a look at the table below. This has the month wise returns for the Nifty along with the annual returns. Few things should be rather self evident from this picture. We have marked in different shades of color the drops that the Nifty has experienced on a monthly basis.
Data Source: Bloomberg
I hear a lot about the extremely volatile markets over the past 3 months. But if you study the chart above it is rather evident that the drops in February and March 2018n are not unusual at all. In the 279 months above the market has fallen in 122, in other words in 46% of the months the Nifty has dropped. Once it dropped more than 20% in one month. In 11 months out of 279 it has fallen between 10-20%. And in a whopping 110 months it has fallen between 0-10%. This can further be broken down into 36 months in which it has fallen between 5 to 10% and 74 months in which it has fallen less than 5%.
If in 122 out of 279 months the market has fallen then we must acknowledge that it is the nature of the beast to be volatile. Even consecutive months of falls are not unusual. In the chart below the same data is now highlighted for consecutive months in which the market has dropped.
Data Source: Bloomberg
Finally also take a look at the annual returns in the final column of the table. The pattern of returns of the Nifty on an annual basis vary rather significantly. To repeat, Gains do not accrue in a linear fashion. I believe these facts are important and should be highlighted to all investors, particularly the surge of investors who are making their way into the markets. In the long term the stock market is a slave to earnings. But in the short term it resembles the outcomes of a voting machine more than it does a weighing machinewhich is calibrated for consistency(paraphrasing Benjamin Graham). Economic cycles, changes in consumer behavior, demographics, technology, policy etc.combined with the emotions of greed and fear create sharp moves in both directions in the market. The best method then is to invest gradually, manage asset allocation in line with your goals and spend a longer time in the market.
So to all investors who are making their way to the equity market I say there are risks and volatility associated the stock market. History suggests that the risks are well worth it because it generates superior returns compared to other asset classes over time and provides the best hedge against inflation. But volatility is normal and returns are not linear. The table above charts the trials and tribulations of the 23 year old Index we call the Nifty. It is in a good place now compared to where it started but make no mistake volatility will be a part of the journey. And the last 2 months have been rather unremarkable when judged against its past behavior.
So, much like a parent dealing with the growing up pangs and tantrums of our children, remember this too will pass. You have to be a bit of an optimist to raise a child and you have to be a bit of an optimist to be an equity investor as well. But there are ways to deal with the volatility – SIP, STP, SWP, Asset allocation funds. Being valuation aware is also important and that should reflect in your asset allocation strategy based on your financial goals. Being prepared for volatility you will hopefully find the ups and downs easier to handle. And every time it gets very challenging think of what your parents experienced before you hit your stride as an adult.