The recent returns from MFs and equity are mouth watering. Pundits have started digging history to show that its danger zone ging ahead. And this gives rise to question – Is Equity – Your best investment long term? If yes how to invest more and make money? Or simply a long-term investment in mutual funds will benefit more? Today we are going through some data and picture which clearly say – Equity is best but- for long term only.
Why Volatility makes Alpha?
Why equity gives better return than gold or debt? One of the reason is Risk Premium. The price or NAV of equity investments is highly volatile. So a person investing would say “ hey I took the additional risk, so I want more”. So equity bounces back and says “stay long term and get that extra return – Alpha”.
Debt is Volatile Too
Some debt instruments like Government Securities or tradable bonds are volatile too but less volatile than equity, so they make low returns in comparison to equity but more than the less conservative products like Bank Deposits or liquid funds.
Indians have preferred debt over equity investments only because of the latter’s volatility. Does that mean traditional debt investments such as fixed deposits, public provident fund, and government bonds are completely volatility-proof & best investment plan?
Shockingly no. Well, some are controlled but they also keep on changing like bank deposit rates or PPF. Data proves that some debt products like Gsecs are volatile too. See this.
Graphically it is like Temple Run
Government bond prices fell 3% and 6% in 2004 and 2009, respectively. Another asset investors favorite gold, too, can lose glitter; prices dropped 11% and 6% in 2014 and 2015, respectively.
If everything is Volatile, Why not concentrate on ALPHA?
Though equity is volatile in the short term, but it is best investment long term as it spell rewards -thanks to the power of compounding. For instance, equity represented by S&P BSE Sensex has returned 14.6% p.a., on average, over 20 years on a daily rolling basis since 1979. Over the same period, debt represented by banks’ FD and gold yielded 9.7% and 10.1%, on average. If average inflation of 8.1% for the same period is considered, real returns (inflation adjusted returns) from these investment avenues can be discouraging.
Real Return= Nominal return- Average Inflation
Equity returns = 14.6% – 8.1% = 6.5%
Debt returns = 9.7% – 8.1% = 1.6%
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Gold returns = 10.1% – 8.1% = 2%
So Equity Investment can be regarded as the best investment long term but… How to avoid losses?
Also, Equity Gives Heart Attack. It makes investors commit Suicide. It encourages Speculations. So how can one earn from Equity Investments?
To really reap from equities, one needs to patiently sow investments for a long period. Rolling returns distribution for various time horizons shows that probability of getting negative returns (or principal loss) diminishes with an increase in the holding period. For a holding period of 15 years and more, equity investment (represented by S&P BSE Sensex) has never given negative returns. Further, there is zero probability of earning returns less than 5% and 10% if the holding period is more than 15 years and 25 years, respectively. That is why I said “best investment long term- is Equity Investments”.
Can Mutual Funds Help?
Only MF can help if you are a retail guy with no knowledge of equity and no time.
“MFs is a service whereby you can hire a specialist who will manage your equity for as little as 2.5% “(or less in case of DIRECT OPTIONS) – Rakesh JhunJhunwala
See the Video of Mr. Jhunjhunwala
Best platform to invest in equities for investors who do not have the necessary requirements to invest directly is Mutual Funds. They are professionally managed and have the ability to generate higher returns than the market.
Long-term performance of various equity mutual funds shows that they have created consistent alpha over their respective benchmarks on the back of fund managers’ expertise.
Large cap, diversified equity, and small and mid-cap funds, represented by CRISIL-AMFI mutual fund performance indices, outperformed their benchmarks by 5%, 4%, and 2%, respectively, over the long term. Mutual funds also offer benefits of variety, convenience, and transparency, and are lighter on the wallet.
Here is how Large Cap Funds performed
Here is how Diversified (Multi Cap) Funds performed
Here is how Mid & Small Cap Funds performed
Investing regularly via systematic investment plan (SIP) can effectively iron out volatility. Rupee cost averaging converts short-term pain into long-term gain. Because more units are accumulated in a downtrend, which boosts the investment value once the market trends upward.
Key takeaway – For long-term wealth creation, one needs to compound investments at higher inflation-adjusted returns.
Equity has this ability. However, assess your risk profile and make appropriate allocation to it. This can only be achieved by professional help engaged in Financial Planning.