The Hindu Business Line : With stocks, a five-year wait may not always pay

Indian investors are mostly sold equity products for a five-year term. But stocks can sometimes deliver negative or low returns over five years. Stock market investors have far more to fear from buying into a bubble than entering a falling market.

Aarati Krishnan

Not much can go wrong with your stock market investments if you are a ‘long-term’ investor, willing to stay put for five years. That is the investment wisdom often used to hard-sell stocks, equity funds or market-linked insurance products to Indian investors. That belief may encourage you to patiently sit on last year’s stock market investments, hoping that a five-year wait is all it will take to restore your portfolio to its former glory.

But experience shows that your faith may be misplaced. Indian stocks have delivered negative returns over some five-year and even ten-year holding periods, if you had the bad luck to plunge in at a market peak. On the other hand, your best chance of earning a good return from stocks lies in catching them at a multi-year low, as they are at now! These are the findings from an analysis of rolling returns on the BSE Sensex since 1986.

Investments in the Sensex held for five years have, on an average, generated a 19 per cent compounded annual return. That appears quite a handsome return. But that ‘average’ conceals some pretty wide swings in stock market returns over different five-year holding periods- some have been exceedingly good while others have seen dismal performance.

Investors who put money into stocks in February 1989 would have been rolling in money five years later — the markets delivered an astounding return of 58.9 per cent (yes, that’s annualised!) from 1989 to1994. But those who invested in August 1997 would have seen their investments dwindle by about 7.5 per cent every year until 2002 — this was the worst five-year period for stocks.

One-in-ten chance

The disturbing news is, times when investors actually lost money in stocks after a five-year wait, have not been sporadic. Daily rolling returns on the Sensex for five-years suggest that stocks suffered losses on about 12 per cent of the occasions in the last 20 years. That means an investor had as much as a one-in-ten chance of losing money in stocks, if he held his investments for only five years. Negative returns on stocks have mostly resulted from investments made at or close to a new market high.

That implies two things for those of us who made the bulk of our stock market investments late last year. One, we cannot count on the healing powers of time alone, to restore our portfolio to health. So, if we have the risk appetite, we may have to commit fresh money to stocks at current market levels to pep up overall returns.

Two, investors whose stock market exposures are way beyond comfort zone because they misread risks should consider a phased exit to correct their asset allocation. For them, even a five-year wait may not help recoup losses.

Now that it is clear that stocks can deliver a poor return or a negative one after a five-year holding period, will a longer horizon of, say, ten years help? History suggests that it will. Not to improve returns per se, but to reduce the probability of low or negative returns.

Looking at the rolling returns on the Sensex for ten-year periods, stocks have delivered negative returns only 1 per cent of the time (much lower than the 12 per cent for five years). That statistic suggests that if you’re investing in the stock market and hope to avoid losses, you should prepare for a ten-year wait.

Holding on for ten years also improved your chances of hitting that 15 per cent target return. For investors who held on for ten years, the Sensex has delivered returns of 15 per cent plus more than 60 per cent of the time.

Whether you have made up your mind to stay on for five years or ten, you cannot hope to earn a healthy return on stocks if you get your timing badly wrong. While returns on the US S&P 500 may show reasonable returns even for investments made at market peaks, the 20-year history of the Sensex tells quite a different story.

Timing does matter

If a 15 per cent return is your target from stock market investments, history suggests nearly a 50 per cent chance of the Sensex not delivering that return over a five-year holding period. That declines to 38 per cent if the holding period is ten years, but is still a large enough probability for you to take it seriously.

Investors who entered stocks near the peak of November 1994 have made a return of just 5 per cent on an annualised basis, till date. This is after a 15-year wait!

Those who invested in the last legs of the dotcom boom (November 1999- February 2000) would till date, eight years later, have made a measly five-year return of 5 per cent.

What all these numbers suggest is that given that debt options in the Indian context comfortably yield 8-10 per cent, there is little reason for risk-averse investors such as the retired or highly leveraged to brave the stock market. After all, there is only a 50 per cent chance of the market delivering a 15 per cent return in five years.

For investors who are looking to the stellar returns possible from stocks, a much more active approach to investing may be called for. That means avoiding big lump-sum investments after a prolonged bull run, re-balancing your portfolio in favour of debt from time to time, taking profits when target returns (say, 20 per cent), are reached and making sure you continue investing in a falling market.

Falling knife

The lesson from all this is not that investors should try to frenetically time the market. Calling a market top or bottom remains well nigh impossible. But they can stick to the simple investment tenet of buying low and selling high.

Investors who were sanguine about committing fresh money to stocks at Sensex 18000 or 21000 levels, after four years of bull run, are today wary of investing at 8800 levels, as it may yet head to 7000! But history shows that Indian stock market investors have more to fear from buying into a bubble than catching a falling knife!

Buying stocks after they have plunged 60 per cent may lead to paper losses in the short term, but remember, they vastly improve your chances of making a decent return over the long term.

Related Stories:
Warren Buffett, the sober saviour
Re-building your fund portfolio
Should you cash out or hold on?
Investment strategy: Accumulating large-caps, timing momentums

More Stories on : Stock Markets | Insight | Investments

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
ICICI Prudential Dynamic Plan: Hold

Bajaj Auto: Hold

ABB: Sell

Index Outlook

With stocks, a five-year wait may not always pay

Axis Bank: Buy

SBI: Buy