“Past performance is not an indicator of future performance” — the literature of every mutual fund you own, mentions something to this effect.

In fact once, when I was lecturing at a mutual fund house, which was not performing well, one of the managers said, jocularly, “Can we say our past non-performance is not an indicator that in future we will not perform?”

And yet, ignoring the past in investing or in any other field is rarely a wise move. What we should understand is that the past is only a proxy for the future.

Wall Street stock investor, Peter Lynch sums this up well; he says“You cannot look in the rear view mirror and drive.“

History is…history! An important lesson from history –  you cannot learn from it!We tend to over-emphasise the recent events of the immediate past, and worry about it. When you look at a fund performance, you will be guided by past history, the true to label portfolio selection, the consistency of performance and so on. However, if you chase performance on the basis of its immediate past, you are likely to be sorry.

There is enough literature to show that equities are an excellent long-term instrument, and very volatile in the short term. Equities outperform other asset classes, and vis-à-vis inflation.In the Indian context if you had invested in the index, in say, 1978-79, and reshuffled it regularly (what an index fund would have done if it were available) your portfolio of Rs 100 would today be worth Rs 18,000.

This is an excellent rate of return, to hope for.

How to calculate stock returns

Studies show that stocks have returned about 19.2% per year from 1980 through 2006. This number however does not include the dividends reinvested. In the USA the dividend reinvested was twice the rate of appreciation.

Any return should be broken up into:

– Inflation

– Dividend

– Appreciation/capital gain

The buzzword: Long-term or average?

Think long-term. Does this mean that stocks have returned 19% per year in most years? Hardly.

The volatility of stocks is legendary. Markets returned a figure as high as 266% in 1992 and followed it up with a 46% fall in 1993. Thus the word average return does not make any sense for a volatile asset class like equity.

Historically we have never had a four-year bull run! Three good years have been followed by one bad year – that is to say March 2008 has to end at a sensex figure less than that of March 2007.

But this is also an outlandish statement. Statistics are to be used very, very carefully, to analyse rather than predict.

Talking about average in equities is like saying: Yesterday the air conditioner was not working, today it is freezing. So, on an average we are comfortable!

But what’s clear is that the probability of making losses is almost nil in case a person chooses a balanced fund, managed by a good manager (fund house), does an SIP and stays invested for say 10 years at least.

This wide disparity of returns makes holding stocks for long periods of time a better idea than holding them for short periods. So, where do we place our bets?

A thumbs down for this bond

If you are interested in steadier, more predictable returns, let’s take a look at bonds, which tend to fluctuate less than stocks. As a rule bonds cannot protect you against inflation. Let’s look at RBI bonds. It pays you 5.6% return (after tax) in a country where inflation is around 7%.  That, effectively is a negative return of 1.4%.

When your advisor says, on an average you can expect to get 19% return over the next few years, what should you do? Baulk!Predicting is difficult especially if it is about the future (Mark Twain).

Surely this 19% return is fine, but the total return on an equity share (therefore a fund) is a function of how much dividends you get, the inflation rate, and capital appreciation that you can expect. If your advisor does not know that, you need to read and equip yourself before meeting him!

Investment wishlist

a. For long-term money, equities remain the best investment.They will not (perhaps cannot) return what they returned over the past five years. But other asset classes cannot be compared to equities.

b. Other asset classes like say debt funds protect your capital and give reasonably good returns. But they are not protected against inflation.

c. Well-diversified funds, index funds, unit linked equity funds (which by definition have a long term horizon) should all be in your wish list.

The final word:

Manage your emotions (this may be the most important part of investing). Lynch says: The amount of money you make is not a function of your IQ, but a function of the strength that your stomach muscles have!

Can you take a churn?

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  1. Considering the economy is expected to grow at 12% over a decade or more, assuming an inflation rate of 6% (which may be conservative), we are talking about nominal growth rate of 18% (12%+6%). Since the over all economy includes agriculture and other components whose growth rate may not be high, good corporates may be expected to grow 1.5X times the GDP.

    In a fast growing economy, there would be sectors and companies which would outpace the economy.

    Past performance though not a reliable tool cannot be ignored totally. Your choice of HDFC, ICICI and Templeton fund houses has got something to do with their past performance. Isn’t it?

    Past performance, with its limitation is always the starting point.

    You’ve mentioned that last 5 years performance cannot be repeated. ‘May not’ be is fine. ‘Cannot be’? I don’t think none of us can be sure about market. Didn’t you say predicting is difficult? It is true for both upside and downside. What prevents Sensex from touching 100,000 in 2020? Can we say for sure, it would not happen?

    Annualized or average return is not a bad word provided one is willing to stay invested for not less than 10 years – preferably through a SIP route.

    Future is always unknown. We can still plan keeping the same in mind. The past 3 decades of annualized index returns of 18%+ may be repeated, may be less or may be even more. The honest answer is I don’t know.

    But I’m convinced equities would give the best possible return in an economy which is poised for a long term growth. Since our base is small, the growth may be significant in the next decade or two.

    The ride would definitely be very bumpy but the end destination should make it enjoyable.

  2. My choice of Hdfc, and Templeton has nothing to do with past performance. When I choose them they had NO PAST PERFORMANCE. In fact I have invested in hdfc growth, top 200, equity, prudence.

    Investments in Franklin Templeton happened again because of the interaction – investments are 12+ years old – surely there was no past performance.

    When Nilesh moved to I Pru, hygiene was ensured. When Naren joined, performance was ensured. Then have invested in Discovery, Dynamic and tax plan – again they had NO TRACK RECORD.

    How and why I chose them? Long answer. Did I use their past performance? Not in a way that the rating agencies make us believe we can. Mercer is the only organisation whose research I am willing to look at for deciding in which fund to invest.

    Hero Honda, Bharti, etc had no track record. Hdfc bank @ Rs. 40 had the parent’s name, but no track record….the worry is many people think they can use ‘past performance’. Such people make price discovery fun. Not that they make money, but they make the market interesting.

  3. Hero Honda, Bharti, HDFC Bank are stocks. Stock picking is altogether a different art.

    I gave past performance as starting point for evaluation of mutual funds. Past performance is not the only criterion for selection but that is also a criterion and many a times a reference point to start the (re)search. The end result of choosing a fund may or may not be on its past performance.

    What is Mercer?

  4. Morgan Stanley – the listed mutual fund available at a discount

    Which fund and what discount are you talking about?

  5. yep MS was available at steep discount (over 20% ) circa 2005.it was a decent buy then.its not bad even now.but its overall since inception return is miserable.it flunked the 1990s and was slaughtered during all the volatile periods

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