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Tired of Waiting for Equity Returns?

Investors who understand the nature of equity investments shouldn't mind the lack of returns over the last five years...

As the months and years pass by without any sign of substantial gains from equity investing, investors are getting testy about where those fabulous promised returns are. A typical email that I got narrates the woe of four years of SIP in a highly rated fund. The writer started an SIP of Rs 5,000 four years ago and then upped the stakes to Rs 7,500 a month two years ago. Currently, the rate of return is just above 3 per cent per annum. Clearly, these are not the kind of returns one signs up for when one starts an SIP in an equity fund with a good track record.

Or does one? It's true that those who sell equity investments--be it stocks or funds or ULIPs or whatever else--may make any kind of claim. However, independent analysts and advisors should say this clearly and bluntly: four years is nowhere near the scale of time on which to measure the returns from an equity investment. For any investment to live up to deliver its full potential returns, one has to look at it over a full cycle of ups and downs it might go through. In equity, the last four years is nowhere near that.

That four years is not adequate is nicely demonstrated by calculating how the above investment would have done had the SIP been started earlier. If the SIP had started six years ago instead of four, it would have had returns of 8.5 per cent p.a. instead of 3. Had it been started eight years ago, the returns would have been 11 per cent per annum and had they been started ten years ago, it would have been 16 per cent p.a. This last rate of return corresponds to a 440 per cent total growth over a decade. Twelve years would have brought returns of 22 per cent p.a., in case you were wondering. And these are certainly not absurdly long periods of time. I know many investors who have sustained uninterrupted SIPs in equity funds for more than a decade and have generated such returns. They may have switched the actual fund as their quality varies but have never stopped the monthly investments.

The apparently magical power of long-term compounding and cost averaging on a volatile asset has to be experienced to be believed. Unfortunately, what investors latch on to are big upswings that are part of the cycle and then expect that to be smoothly sustained. Sure, stocks about doubled over 2004 and 2006 and then doubled again over the next two years but you can neither extrapolate that, nor predict that.

If you want a rule of thumb, then here's one. Over a long period, you can expect stocks as a whole to grow about as much as nominal GDP does. If you compare the average GDP for five years ending 2000 with the average of the latest five years with the Sensex, then the GDP is up 5 times and the Sensex is up 4.6 times, which is good enough for me. There are all sorts of caveats to this--the Sensex is not all stocks and why five years etc but it's a rule of thumb and that's the way they are. This relationship doesn't hold if one goes back past about 1993--I guess we were a very different sort of economy then but you can expect it to hold from here on.

And if you invest regularly, thereby capturing extra returns from volatility, then you're pretty unlikely to go wrong. If the last four years have given returns of 3 per cent while the economy has grown at nominal 15 per cent, then you should be happy because you're going to get back those returns in the future. These four years are actually good news because you've been 'buying low', which is the best thing to do.