How to invest when stocks are on a high & still make money
The equity market is on a high these days. The Sensex hit 31,291 on June 22 2017, rising about 17 per cent from a year ago and about 19 per cent year to date (YTD). Given the phenomenal rise, should investors continue to park funds in stocks?
Different people have different investing styles. While some follow aggressive styles with shorter investment horizons, most believe in investing for the long term with a minimum of three- to five-year outlook.
During a discussion at work, a colleague made an interesting point - his equity mutual fund SIP opened in January 2008 (the high point of that market cycle) has yielded him an annual compounded return of 12 per cent till date; he continues to hold on to the same.
While one may argue that this is no great feat as the return in absolute terms is not much to write home about, the key takeaway here for readers is that despite investing at a time when valuations and markets were at a peak, this particular investment has yielded him 1.5 times returns of what he would have otherwise got had he invested in a debt instrument at the time. That too pre-tax!
What we are trying to infer is that long-term investing works. And taking such an approach, especially now, would be the right way to go about things.
One may raise a point, the fund my colleague invested in may be one of the few that have done well over the long term, thanks to the fund manager whose wisdom allowed the unit holders to garner such returns.
While that may be true, here are some interesting data points that seem encouraging enough for an investor to take up this approach on his own.
From the market peak on January 10, 2008, the Sensex has risen by around 4.5 per cent per annum. The comparable number for the BSE500 index is about 4.8 per cent per annum. But if we look at the returns of the constituents of the BSE500 index since then (considering only 80 per cent of the index companies were listed nine-and-a-half years ago), some interesting data points can be observed.
A little less than a fourth of the stocks continue to trade below their January 10, 2008 closing levels. About 11 per cent of the stocks have given positive returns, but underperformed the BSE500 index i.e. compounded returns have been positive but less than 4.8 per cent. About 9 per cent of stocks have outperformed the BSE500 index, but have generated returns less than what they would have otherwise got through debt instruments (assumed at 8 per cent). A little more than 8 per cent of the stocks have beaten the returns on debt instrument, but have been lower than the minimum return that one should expect from Indian stocks (1.5 times of 8 per cent).
What is particularly interesting is that 48 debt instrument of the index stocks have given compounded annual returns in excess of 12 per cent. The median of this basket of stocks was a high figure of 20.8 per cent.
What does all of this point towards? Three things I believe -
First, equities have the tendency to outperform other asset classes over long periods.
Second, one should have a long-term investment horizon.
And finally, stock selection is critical.
But how should a lay investor go about doing the same?
We believe the Indian economy is at an inflection point, with strong structural changes being observed within the economy. And thus, growth levels are only going to remain firm, if not rise, going forward.
All one needs to do is weed out the companies with poor fundamentals. A simple approach one can follow is to invest in companies that have a long runway of growth: companies that possess pricing power; companies whose strong historical performances are likely to remain intact in future; companies where disruption and competitive pressures are unlikely to hamper their quality of earnings; companies that are market leaders in their respective domains.
We recommend a systematic transfer plan-like structure wherein investors can park their lump sum fund in a short term debt fund, with the funds getting systematically transferred from such accounts to directly purchase shares of the shortlisted companies on a monthly or quarterly basis, thereby allowing the investors’ idle money to work for them while making the most of the market movements.
This process also helps in keeping the market noise out in the decision making process, while allowing regular financial savings – those that would form the basis of long-term wealth creation.