How do equities perform in long-term?

How do equities perform in long-term?
Highlights

In general, investors and advisors alike associate equities and related investments with long-term option, though no one is clear about how long is long? The other reason being the risk associated with this asset class which is relatively higher than bonds and gilts, etc. and thus the possible returns.

In general, investors and advisors alike associate equities and related investments with long-term option, though no one is clear about how long is long? The other reason being the risk associated with this asset class which is relatively higher than bonds and gilts, etc. and thus the possible returns. But, should we consider equities as the best asset class for investment for the long term? The performance of equities remained endemic in nature where islands and pockets of outperformance and may not be true when considered across the world markets.

As an investor, in 1900 one might have picked Germany as a rising power, only to see their asset values wiped out during the ‘20s hyperinflation and then the Second World War. It would have been a very contrarian bet if someone picked up the United States which then was an outlier, turned out to be a successful economy of the 20th century. Study by Elroy Dimson, Paul Marsh and Mike Stauton of the London Business School who compiled data covering 22 countries over a century of timelines, have thrown some interesting insights into the equity performances across the world.

Data till Feb 2013, in over 112 years shows that the longest period of negative real returns from the US equities was 16 years while it was 19 years for global equities. It’s surprisingly much higher at 37 years excluding the US for the global average. Comparatively, it is 22 for Britain, 51 for Japan, 55 for Germany and 66 for France. Most of these periods are far higher than the life time of investing for an ordinary investor. Another interesting point to note is that even in the US, there was a point in 2011 when equities have lagged Treasury bonds over the previous 30 years. For that matter, London’s FTSE 100 is still below the level it hit at the end of the last century.

Whether one may complain about the consideration of the starting point or contest on the valuations, it is true that equities could underperform. And with the current market turmoil and fluctuations across the world equities due to various global risks, the role of this asset class seems to be questioned more than ever. At this juncture, how could one approach investment strategy and utilize this asset class to ones benefit. Hence, it’s also imperative to be agile and active while investing in equity, especially if it’s into direct equity.

While approaching equity, one needs to follow an important way of having a target price. As and when one hits the pre-defined target, one could either resort to profit-book or exit. Then a fresh target needs to be assessed and fixed before deciding to either continue to be invested or averaged on. When investing in a passive investment like equity mutual funds, one may approach with a systematic way and opt for a similar strategy once in a while.

Of course, this is where asset allocation and diversification come in to play for attaining better returns. One must understand that no one investment avenue is the best or panacea for any need or timelines. All of them have their own limitations and we should design these asset classes with respect to our risk appetite and timelines for our advantage. The above study, however, questions some of our age-old impressions and traditional thinking about equities. Though, this doesn’t defunct equity as an outperformer as an asset class but it also highlights the risks associated can’t be undercut.

(The author is a practising financial planner and could be reached at k.naresh.k@gmail.com)

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