Tempering the Modern Investor’s Expectations

Sensex has returned over 75 per cent since the precipitating fall in March last year. This period of abnormal volatility and a devastating pandemic has witnessed opening of over 10 million new demat accounts, spawned fresh millionaires and has created an irrational breed of investors, typical of all bullish periods. The economies that have already witnessed widespread adoption of equity investments have an important lesson for us – it is that stock market is an abode of excesses and anybody who falls prey to it loses money.

In the current market situation, optimists believe this party would last forever, pessimists feel the underlying economic pain caused by the pandemic is being ignored by the market and this bubble would burst soon. The most distant from truth are those who expect that doubling or tripling of money every 6 months is the norm. We call them the ‘stormchasers’, who abhor the ‘meagre’ return of stock markets, lured by the imminent fortune in grapevine trading, with little or no research and without any heed for risk.

The most frequently asked question of our prospective clients has changed from ‘What is the risk involved with my investment?’ to ‘Can you double my investment in a few months?’ Retail investors staking their hard-earned money in the market are at risk of losing capital. It is important to set expectations right initially, to avoid disappointment later, and to set goals that are practical. A good way to set the right performance expectation is to start by learning from the past.

Since the inception of the index in January 1986, Sensex has returned 13.64 per cent CAGR to investors. The American index S&P500 has returned 8.43 per cent CAGR over the same period. Historical performance does not equal or guarantee future performance, but as Mark Twain said, “History doesn’t repeat itself, but it often rhymes”. An ideal performance estimate must be tempered based on these historical figures.

A client recently asked us why we were targeting a paltry 30 per cent yearly return when a Telegram trading group that he was on, helped him make twice that in a month. As Madeline L’Engle put it, “Maybe you have to know the darkness before you can appreciate the light.” So, a good way to temper expectations is by reading about recessions and bear markets, which are as frequent, if not more, than the good times. India has witnessed over 20 crashes since 2000, with crash defined as a decline of more than 9 per cent within a span of 5 days in Nifty (The definitions of crash and recession vary widely).

While the concept of investing has been around for centuries now, there are still ambiguities that plague even the most basic of its tenets among the masses. For example, confusing trading with investing and vice versa. Jason Zweig’s write-up for the Wall Street Journal may help the stormchasers choose their calling. Understanding whether you wish to invest in index funds, pick stocks yourself or hire an advisor is crucial to achieve what you set out to do. This instils discipline in your investing. This clarity does not emerge immediately but is created incrementally as you explore the market. It is crucial that you do not lose your capital before this clarity emerges. Thus, an important of goal planning and setting performance targets is also to have clarity of the investment strategy.

When making the first trade or investment, one is most likely to make a quick profit by sheer luck. To extend this winning streak and make material profit over the long term, it is important to not just analyse performance but also the risks involved and the reason for the performance. Otherwise it is easy to confuse luck with skill. Achieving a 100 per cent return in 6 months once is exponentially easier than replicating it for the second time and even more difficult replicating it several times over the years. Targets are best constructed with a long term outlook and not clouded by short term optimism. Consistency is critical and small changes in return can create tremendous effect on your wealth as the ‘t’ (time period) is in the compound interest formula rates consistency higher than occasional outbursts of exceptional performance, as in the recent past for most.

Summary

•          Practical expectations lead to practical plans and eventually to achievable goals.

•          Historical performance is a good benchmark to set responsible targets.

•          Attempt to achieve clarity in investment strategy

•          Do not confuse skill with luck and vice versa

•          Consistency is key

The writer is the Founder of Savart Investment Advisory

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.