The longer you stay in the markets, the more you are likely to earn returns by letting the magic of compounding work for you.
By Susmit Patodia
Down markets are very tough to handle primarily because of two factors that stress us: We think things are going to get worse, and secondly, we feel a sense of loss of control.
To these you add the third that we are subject to in this lockdown: very few avenues to let off steam. The three together are a potent force to ensure that most of our decision making is taking place when we are stressed, which leads to more short-term frame of reference during the decision-making process. This is what causes a lot of us to bail out nearly almost always at the wrong time.
Money in the markets
This brings us to the next aspect which is how do we make money in the markets. There are two ways to make money in the markets from a timing perspective. First, we always sell at the top and re-buy at the bottom. Second is to remain invested and not worry about the timing. This is what you would have often heard from most successful long term investors as it is not about timing but spending time in the markets.
The first way involves two extremely tough decisions to be made and both have to be right for us to make money. The second one involves no decision making but a lot of stomach to digest the quotation loss. Most of us want to try the first way of timing as the upside is huge if we get it right and more importantly, it involves a lot of decision-making. In tough times like these, we love decision making because the more decisions we make, the more in control we feel. Here is where the data is interesting and gives key insights into why fewer the decisions we make the more we are likely to make money in the markets.
Time in markets
Nifty in the last 30 years (10,900 days) has returned a CAGR of 12.2% which gives us a return of 31 times. Data show that bulk of equity returns are made in just a few days. If you missed just 30 out of the 10,900 days, your returns came down from 31 times to just three times. The near impossible part is to figure out which are those days, hence spending time is important as these days can happen when you least expect them to.
Next, 60% of the best 30 days of returns actually happened in bear markets which if we try to time are most likely to be missed. The logical next question is why does this happen. The famous Anthony Bolton (one of Fidelity’s greatest fund managers) said: “The most money in equity markets is made when things go from bad to less bad.” That is the most lucid answer to the question.
So, stick to time in markets vs timing the markets.
Equities are the only investments that allow you to earn return on returns. The second advice is that compounding is a mathematical truth. The longer you stay, the more you are likely to earn returns by letting the magic of compounding work for you.
The writer is associate director & fund manager, PMS, Motilal Oswal AMC