What you must understand about equity returns

When I had written a post on Equities and compounding, one of the financial planners wrote to me and expressed his anxiety that my stating that equity returns were not time dependent like debt, may impact people investing in SIP etc. Note that he did not say I was wrong, as he obviously knew that I was not. Now, I have no problems if people want to invest in equities thinking that the amount invested will grow like it does for a standard debt product. However, as someone who runs this blog I will try my best to disseminate the right type of knowledge.

Let me take a simple example to demonstrate what I mean by equity returns not being time dependent. Many of you have bought MF through SIP over the last few years. Look at your purchases in the last 12 months and check the returns on those – it is a fair bet that you will find these to be in the negative zone. However, if you had invested in the same funds throughout 2013 and checked the returns one year later, it would have shown you returns of nearly 20 % or maybe more. Based on both of these can we say what will be the returns in 1 year for the investments we are making today? Unfortunately we cannot do so. Equities can work greatly in the short run or may not work at all. The same is unfortunately true for a longer time horizon, though the probability of negative returns does reduce significantly with increasing time period. You can look at the rolling returns on Sensex and Nifty to get a better understanding of this.

So if the returns on equity are so uncertain and you cannot depend on it at all then why should you be investing in equity. Well for most of us the answer is simple – with the kind of inflation we have in our country, equity is the only asset class that allows us a chance to meet our financial goals. If I had enough money to meet all my financial goals with 4 % return then I will keep all my money in a SB account. Unfortunately, most of us do not earn at that level and thereby need our investments to give us higher returns. If there are people who do not need this higher return my serious recommendation for them will be to stick to fixed income instruments and be peaceful.

In summary, irrespective of what people tell you remember these about the equity asset class returns:-

  1. The returns do not compound with time, like in debt instruments.
  2. The returns are non-linear in nature that is, you can have a high return year followed by several flat years or also exactly the opposite. 
  3. Secular bull and bear markets will really be rare in a market like India where issues are complex and there is a lot of dependence on FII money.
  4. Over the long term you will have good growth in equity but the duration is difficult to predict.
  5. Even when you have got good growth, there is no certainty it will stay that way. Think of how good your SIP investments looked in 2015 March and how they are looking today.
  6. Never depend on equity returns for a time bounded goal. If your son has to start college this year you cannot postpone it. Depending on equity to fund it in a poor market is going to hurt you financially.
  7. In case you are not OK with the above then equity is not for you.

There are a lot of other posts in the blog which will give you a great learning about equity as an asset class and how to invest in stocks and MF. Go through them and it will enrich your investment life significantly.

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One thought on “What you must understand about equity returns

  1. with real interest rate being in the range of 1.5 to 2.5% and interest income being subject to tax, long term capital gains on equity, indexation, tax free dividend, bonus shares, stock splits (sentimental value) are all pluses.

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