Dear reader, if you have read my previous blog on “Finance for Everyone: The cost of Indecisiveness in Investing”, you will know about my conversations with Pooja. She wants to get started with equity but still has apprehensions about risks associated with it.
Rip Van Winkle & the Art of Investing
It is normal for lay investors like Pooja to be worried about risks associated with equity markets. When asked what the market will do, J.P.Morgan had famously quoted “It will fluctuate.” Fluctuations are intrinsic to the equity markets. Nifty 50 has fluctuated up & down every day over the last few decades while rewarding the investors who stayed the course. I will explain why the risks associated with equity get magnified and most retail investors either stay out of the markets or abandon it prematurely. The reason for that are the workings of the human mind and how print & electronic media report market news.
Somehow the imprint left by negative news on human brain lasts longer than positive news. Perhaps it has its origins from the early caveman days where not acting on negative news e.g. the presence of a predator nearby, could mean the difference between life and death. I looked at the data of Nifty 50 for the last 7125 trading days in the last 30 years. There were 3306 days where the market fell. This translates to 46% of the trading days. For someone who is watching the news, it appears as if the market is falling every other day. The fact that the market has gone up in the remaining 54% of days simply does not feel that way to the human mind. To a human brain it appears that there is more bad news than good.
Print & Electronic media, as is their wont, also sensationalize market falls. If the market fell by 2% or more, the headlines scream “Bloodbath on the streets”, “Market plunges by 1200 points”. The Nifty 50, has indeed, fallen by more than 2% 433 days in the last 30 years. That’s an average of 14 times in a year. When the human mind looks at such news screaming “bloodbath” on 14 occasions in a year, it concludes that stock markets are indeed a dangerous place and avoidance seems like a good idea. What has gone unnoticed that in these 30 years, where markets were falling every other day & “bloodbath” taking place 14 times every year, the Nifty 50 went up from 1042 to 21731 i.e. nearly 21 times.
Let me now share the story of Rip Van Winkle.
Rip Van Winkle, is a story about a Dutch-American villager in colonial America who meets mysterious Dutchmen and falls asleep. When he wakes up, he discovers that everything is different and his beard had grown a foot long. When he trekked back to the village, he couldn’t recognise anyone. His house was in a very bad shape and he met a woman who looked a lot like his wife but was not his wife. After talking to her, Rip realises that the woman is actually his daughter. He becomes happy, but his happiness is short-lived when she says, “My father disappeared almost 20 years ago. I haven’t seen him or our dog since then. My mother died a few years ago.”. That is when Rip realises that he fell asleep for 20 years and has missed many events including the American Revolution.
Pooja: What is the relevance of this story to investing?
Me: If we have chosen the right equity funds, going off to sleep like Rip Van Winkle isn’t a bad thing and it may actually help us take a long-term view. Let me explain this using data. Let me now take the data from 1990 and explain that we will actually benefit if we take a long-term view. I have plotted the year end Nifty 50 levels. Let us see what happens if three gentlemen Ravi, Sandeep & Vikram at the end of 1990 took three different time horizons to buy and sell. Ravi took a 1 year view; i.e. he bought in 1990 & sold in 1991, bought in 1991 & sold in 1992, so on & so forth. Sandeep took a 5-year view i.e he bought & sold only after 5 years while Vikram took a 10-year view. Let’s see what they experienced since they started investing in 1990:
| Annual Returns generated in the Period | ||||
| Year End Closing | Nifty 50 level | 1 year View:Ravi | 5 year View:Sandeep | 10 year View:Vikram |
| 1990 | 330 | |||
| 1991 | 558 | 69.09% | ||
| 1992 | 761 | 36.38% | ||
| 1993 | 1042 | 36.93% | ||
| 1994 | 1182 | 13.44% | ||
| 1995 | 908 | -23.18% | 22.44% | |
| 1996 | 899 | -0.99% | 10.01% | |
| 1997 | 1079 | 20.02% | 7.23% | |
| 1998 | 884 | -18.07% | -3.24% | |
| 1999 | 1480 | 67.42% | 4.60% | |
| 2000 | 1263 | -14.66% | 6.82% | 14.36% |
| 2001 | 1059 | -16.15% | 3.33% | 6.62% |
| 2002 | 1093 | 3.21% | 0.26% | 3.69% |
| 2003 | 1879 | 71.91% | 16.28% | 6.07% |
| 2004 | 2080 | 10.70% | 7.04% | 5.81% |
| 2005 | 2836 | 36.35% | 17.56% | 12.06% |
| 2006 | 3966 | 39.84% | 30.22% | 16.00% |
| 2007 | 6138 | 54.77% | 41.22% | 18.99% |
| 2008 | 2959 | -51.79% | 9.51% | 12.84% |
| 2009 | 5201 | 75.77% | 20.12% | 13.39% |
| 2010 | 6134 | 17.94% | 16.68% | 17.12% |
| 2011 | 4624 | -24.62% | 3.12% | 15.88% |
| 2012 | 5905 | 27.70% | -0.77% | 18.37% |
| 2013 | 6304 | 6.76% | 16.33% | 12.87% |
| 2014 | 8282 | 31.38% | 9.75% | 14.82% |
| 2015 | 7946 | -4.06% | 5.31% | 10.85% |
| 2016 | 8185 | 3.01% | 12.10% | 7.51% |
| 2017 | 10530 | 28.65% | 12.26% | 5.55% |
| 2018 | 10862 | 3.15% | 11.50% | 13.89% |
| 2019 | 12168 | 12.02% | 8.00% | 8.87% |
| 2020 | 13981 | 14.90% | 11.96% | 8.59% |
| 2021 | 17354 | 24.13% | 16.22% | 14.14% |
| 2022 | 18105 | 4.33% | 11.45% | 11.86% |
| 2023 | 21731 | 20.03% | 14.88% | 13.17% |
| Total Number of Periods | 33 | 29 | 25 | |
| Number of Periods with Negative Returns | 8 | 2 | 0 | |
| Probability of Loss | 24% | 7% | 0 | |
Ravi had experienced 33 periods each lasting one year and what a ride it was. Out of 33 periods, there were 8 periods (marked in orange) where the annual returns were negative i.e.24% of the time he had negative returns. In fact, in the year 2008 he saw his investment more than halve and Ravi almost swore never to get into stock markets again.
Sandeep, who took a five-year view had 29 periods each lasting 5 years and he saw only 2 periods where the returns were negative i.e., he saw negative returns only 7% of the time.
Vikram behaved like Rip Van Winkle i.e. once he bought, he would not look at it until another 10 years, had a very different experience. If you go through the data, he had 24 periods each lasting 10 years and he never had a period where his returns were negative.
While Stock markets do carry risks of negative returns, the occurrence of it can be hugely minimized if the investor takes a long-term view. Choosing the right equity fund, investing in it and then going off to sleep like Rip Van Winkle is arguably the best thing to do.
Authored By
Prof. Subhasish Acharya
NCU School of Business
The NorthCap University