Equity Markets give good average returns!

There are so many people today masquerading as financial planners, financial trainers, financial experts on media…I was amused when I heard the statement ‘Equity markets give good average returns’. If you ask me this is brilliant but useless advice!

Why?

Because to understand equity markets you need to understand Arithmetic Mean, Geometric Mean, Standard Deviation, Mode, Median, and preferably regression to the mean. If you do not, you are up shit creek. Welcome to the world of statistics. Now let us see this in simple plain English…..

The best example that I have heard as a trainer regarding averages and standard deviation is the following:

 

If one leg of yours is in the oven, and the other in a freezer, on an average you are comfortable. This is a big learning in statistics – the word average makes no sense if the standard deviation is very high. In cricketing language if you see Shahid Afridi and Rahul Dravid, – the 2 of them have an average of 22 and 58 respectively. However, Shahid Afridi has a high standard deviation and Rahul has a low standard deviation.

 

Which means whenever Shahid Afridi goes out to bat, the probability of his getting 22 is NOT AS HIGH as Rahul Dravid getting 58.

 

However, you need to remember that over the past 20 years, Rahul has an average of 58 and Shahid has an average of 22. So if you believe in regression to the mean, the average will catch up.

 

The stock market isn’t much different. Over very long stretches, stocks, on average, have returned around say 18% annually. But in any given year–or even over several years–the stock market can diverge markedly from its long-term average. Throughout the prosperous 1978-79 to 2000, for instance, till 2000 the Sensex rose 24% per year. No wonder Sensex was widely called a can’t-miss investments. However, from the year 1990 to the year 2000 the sensex moved from 1000 to 6000 – giving a return of 20% per annum. How has the sensex fared from the year 2000 (at 6000) to the year 2008? The answer can vary from 11% (index 13700) or 17% (index 21000).

 

I am sure you understand what I mean. The word average makes no sense at all when we talk equities. Equities gyrate, and gyrate like this. So please do not use the word average when talking average. If you use the word average remember that markets have given returns of 240% followed by a -42%. Imagine what happens to YOUR money if you entered just AT THE PEAK? next year you see YOUR portfolio down almost HALF! That is not easy. So when you see a huge deviation from the mean, either invest aggressively OR sell aggressively (hoping for regression to the mean)!!

 

Did you know that if you got a 50% return in the markets, followed by a 50% fall, you would actually be poorer? do the math!

If you use the word average, it clearly shows you are mathematically challenged and you do not understand the word standard deviation.Or just be plain silent.

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6 Responses to “Equity Markets give good average returns!”

  1. ‘So when you see a huge deviation from the mean, either invest aggressively OR sell aggressively (hoping for regression to the mean)!!’

    indeed very useful advice. should diversified equity mf investor leave the actions to the apt fund manager ?

  2. No. Fund manager cannot decide on the amount that YOU need to invest. So if you are doing a SIP for Rs. 15,000 and you feel that the market is down, just put say 100,000 into that fund. If you think that the returns are too high, withdraw from the fund…that is all

  3. yes this post put a big slap on the SIP investors trying to get the AVERAGE return of SENSEX 🙂

    I wish investing in market were that simple..DO SIP and Sit and watch for your retirement. Moreover that law of STD Dev. takes a toll heavily during Systematic withdrawal phase.

  4. yes Nitin. In my book on Retirement I have said how swp kills…and for withdrawal strategy has to be very very different…

    swp fails EXACTLY because why SIP wins!!

  5. Subra Sir

    I am a great fan of Flexi SIP program for the above reason where i can increase the SIP amount with falling markets for the same reason.

    Also would appreciate to know your view on Parag (PP MF)

    Thanks

  6. Nitin,
    You should rebalance your portfolio every year. It should be clerical work. Don’t make any tactical asset allocation. Make sure to have asset allocation which does not disturb your sleep at night.

    For example, I am trying to get to (50% real estate, 40% debt and 10% equity) in next 5 years. Currently my portfolio is skewed towards real estate.

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