Friday, February 1, 2019

The Fallacy of Long term returns in Stock Market

“Invest in stock market”, says my friend a stock market enthusiast.

 “Why?” I question. I am not a fan of seeing my money vanish into thin air.

“In the long-term you make high returns in the stock market. Look at Sensex. It was valued at 100 in 1980. Today it is 36,000. If you had invested a Lakh (100,000) of rupees in Sensex in 1980, you would be sitting on 36.000,000, that is almost half a million USD at the current exchange rate” my friend is gloating.

Ah, the ‘Long-term’ card.

I want to point out to him, but I don’t, that Sensex was trading at around 400 in the early 90s and 2000 in the early part of this century, good returns, but not as huge as the kind of growth that happened after 2009.

I also want to point out the four fallacies in the ‘Long-Term’ growth argument. The idea of ‘Long-term’ returns is true if you consider really Long-term like 35 year in case of Sensex.

While it may be true from a market perspective, it will not be true from an individual investor’s perspective. There are four reasons why Individual investor do not make the kind of returns from Stock Market that the market history suggests. First reason is that the individual investor has a relatively shorter life span while the market is eternal. If you take US market for example, in the 20 year slow down after the big crash of 1929, many individual investors went bankrupt. And there has been three periods of long term correction in US Markets in the 20th century.

Even for our markets, the years from 1980 to 1995 were laboured and painful. It was difficult for individual investors to trade in the markets. Coterie of brokers and other vested interests ruled the market and fleeced the individual investors. ‘Insider trading’ was rampant and information was hardly available. It was very difficult for investors to enter and even more difficult to exit the market.

The challenges of that time in the Indian Markets are beautifully captured in the book ‘Bulls Bears and Other Beasts’ written by Santosh Nair.

Entry to market  and Exit from Market was difficult if you were an individual investor. So you are hesitant to invest and hasty to withdraw. Your long-term definition is different from the market definition.

That is the first reason for the fallacy of 'Long-term'. There is no clear definition of Long-term. If you invest in the market top like my brother did back in early 2008 when market touched 22000, all he has to show for staying invested in market for 10 years is a measly 50% return, which is about 5% per year. Had he invested in FD at that time, he would have got about 12% interest and his money would have become 3 times by now.

10 years is a long-term by any stretch of imagination, don't you think?

Long-term from perspective of investor is 10 years, may be 20 years. But from the perspective of market long-term is from the day it started till today.

It is the apples and oranges thing.

The second reason is that individual investors withdraw their savings for consumption in Future. Every rupee that you consume will lower your long-term returns significantly due to the effect of compounding.

Let us take Indian Market as example. Let us say that you invested 100000 rupees in 1980. By 1991, it had become 300000. Let us say you withdrew 50% of your investment. Now you are invested 150000 in Sensex. By early part of this century, your investment is worth about 10 Lakhs.

Now assume that you have withdrawn another 50% and are left with 5 Lakhs in the market. At the current rate of 36000, your 5 Lakh is worth about 90 Lakhs.It is about 11.5% CAGR Pre-Tax. In 1980 you had long-term 20 year bonds giving 16% coupon rate.

Where is 360 Lakhs and where is 90 Lakhs? And it happened because you had 'Consumption' requirements.

And now we come to the third reason, the pain that you took to stay in the market, the fear that you had to overcome, the tension you had to endure.

During these 40 years, the markets were volatile most of the time. There were at least four corrections, One in 1992 (Harshad Mehta), one in 1995, one in 2000 (Asian Currency Crisis) and one in 2008. It would have taken tremendous will power to stay invested in the market during those blood baths. And god forbid if you had to withdraw your savings during these corrections. You would have got very less returns and the remaining investments also would have been lower by that rate. (Imagine if you  had to withdraw 50% when the market was 200 and again when the market was 1000, you do the math)

And there is a fourth reason, what is called Survivorship bias. Had you purchased the shares of Tata Steel in 1980, you would not have got the kind of sterling returns that you see in Sensex. There were many companies that went bankrupt during the time. History do not talk about those companies. It is written by winners. If you had purchased shares in some of the vanquished companies, your ‘Long-term’ returns would have been wiped out.

The moral is this. If your long term coincides with the market growth, you will make money. Else if your only long term strategy is equity, if the reverse happens in the markets, and your long term coincides with the long term down turn in the markets, you may be looking at doghouse and trailers to survive your old age.

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