At some level, investors' uneasiness about the last five years is rooted in an unrealistic expectation of the manner in which equity returns are generated. We use the word volatility but we don't appreciate the meaning of the word. Even if we understand the meaning of the word in the dictionary sense, we don't appreciate living through volatile times.
Look at the accompanying graphs, which show the BSE Sensex from its first full year (1980) till 2010. In the graph on top, the bars are each quarter's returns over these thirty years and the straight line is the effective return over these years. In the second graph, we show just six bars, each representing a five year period and the straight line is the same -- the effective return over the thirty years. It's like magic -- all the volatility seems to have almost disappeared!
This the reality of equity and it is not going to change. The question you have to ask yourself is whether you are willing to take it five years at a time or whether you are going to give yourself either euphoria or high blood pressure on a daily, monthly or quarterly basis.
In the long run, one can reasonably expect average equity returns to at least track the nominal growth of the economy. If you compare the average GDP for five years ending 2000 (1996-2000) 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 close enough. There are some caveats here - the Sensex is not all stocks and this is just a rule of thumb. But, the point that you need to keep in mind is that it pays to stay invested for the long term with equity investments.
This article was originally published on October 18, 2013.
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