Can equity be a fearless investment option?

The greatest enemy of any investment is inflation. In the developing economy like us we have to live with high inflation.  When we talk about inflation its not just CPI or WPI numbers as published by the government every month but there are various other services like what we pay to doctors, school fees, barber etc. which are not covered in the index but has a very significant impact on our investments and savings. It means that the inflation-adjusted interest rates that we earn from fixed-income investments like deposits etc are actually negative when compared to the real inflation rate that consumers face.

  

This inflation is due to structural and demographic reasons and could not be solved in a very short period. Hence it could be years before we get positive real returns from fixed income securities (FDs, bonds etc). In this scenario equity is one of the assets that has the potential to beat inflation to earn real returns. It is for this reason that we should have a significant exposure to investments in equity in any of the investment portfolio.

However when we talk about equity investments any normal investor’s first reaction is that it is risky. The risk of losing money is more dominant than earning and keeps most of the investors away. Further short term ups and downs and coverage by print and electronic media gives the impression that the investments will always be moving ups and downs without giving any stable returns. As the stock market goes up brings lot of happiness with the investors on the other moment as it falls they get devastated.

However when we talk about equity, this volatility is an illusion. How can this be? How can returns from a type of investment that is volatile be high and safe. The answer is to understand that the same thing can look very different at different scales.

Let’s take an example of a man playing with a yoyo going upstairs. Everyone watches the yoyo which is moving up and down but does not see that the man carrying the yoyo is actually going up. Similarly in reality, the returns from equity are not only high but they are quite safe too.

Let’s take another example. What is the coast line of India? The official answer is 7,517 km. But will everyone have the same experience awhile covering the entire coast line. from Gujarat to West Bengal. If an ant walked the entire distance, would it come up with the same answer as a man will walk through? And how about an aeroplane covering the same distance?.

In each of these cases the answer would be very different. The ant may come up with an answer thousand of km higher because it would follow each nook and corner of the coast at the scale of millimeters. A human being would follow it on a scale of feet and come up with a lower answer. An aeroplane would follow it only on the scale of many kilometres and would come up with a far lower answer.

Stock market volatility is a bit like this. If we track the markets everyday, we will see many ups and downs. If tracking it once a month, there will be fewer ups and downs. On the scale of an year, the ups and downs would be even fewer and if we look at the markets only once every two or three years, there would hardly be any volatility. Now, imagine the scenario once in a decade or for even longer periods.

Let’s see the two charts below. One is that of the BSE Sensex' daily movements from 1990 to 2015. The other is the same time period, but marked only once in five years!

The first graph can put the most intelligent and smart  investors also in a difficult and worrisome situation. However, the second graph is very smooth and shows practically no volatility.

For example is we had invested in stock market in 1990 and then checked the investments only once in five years, then sometimes it might have risen more and sometimes less but would have given positive returns most probably. Over longer time such as a decade or more, the movement of Sensex evens out, thereby reducing volatility in reality.

Like we cannot cover a 5000 km distance by a cycle but an aeroplane whatever risk it may look like similarly to cover our bigger financial goals over a longer period of time, equity is the best option.

The message for the investors is: that investing in stocks can lead to frequent losses only if we are a short-term trader. Over sufficiently long periods of time, it is  like aeroplane flying over the coastline. The little twists and turns that vex the ant are not your concern. But do we need to invest in equities directly? Its not required if we are not experts its always better to taken the services of experts. So to invest in equity sensibly and make money out of it, there's no need to actually get into stocks and shares ourselves--equity mutual funds will do the job for us.