In the recent past, the equity market has witnessed heightened volatility with broad indices correcting by 6-7%. Why has this happened and how must an investor react?
Unexpected global and domestic events have impacted market sentiment.
The outcome of the U.S. presidential election and the consequent impact on interest rate expectations, particularly in the U.S. with analysts expecting stronger growth and higher interest rates, has resulted in FPIs pulling out money from various markets including India.
The announcement of demonetisation of high value notes has raised uncertainties around the performance of the economy, particularly over the near term.
The long-term impact of Donald Trump’s election as the U.S. president on the Indian economy may be limited and would be known once specific policies are announced by the new administration. On the other hand, the negative impact of demonetisation would be felt over the next few quarters on account of a slowdown in consumption, real estate and allied sectors. Over the long-term this move should benefit the economy. This would be on account of growth in the formal economy (against the parallel economy), higher tax collections potentially helping an increase in infrastructure spending and boosting the fiscal situation besides reducing corrupt practices and improving transparency in governance and administration.
So what must investors do?
Stick to your long-term investment plan devised on the basis of your investment objectives and risk appetite.
Trying to time entry into and exits from equities based on such events is a futile exercise due to difficulties in predicting short-term market moves. For example, if one had invested Rs 10,000 in the market in 1991 and had held the investment for 25 years, through the significant number of market events and volatility, it would have grown to Rs 147,791 (generating an annualised return of 11.4%). On the other hand, if one had tried to ‘time’ the market and in the process missed the top 10 performing months during this period the value of the investment would be only Rs 18,969 (generating an annualised return of 2.6%).
And if one had missed the top 20 performing months, the value of the investment at the end of 25 years would be Rs 5,523 (generating an annualised return of -2.3%). An important point to note is that most of these top performing months have been preceded by months where returns were either negative or very low. A similar pattern is repeated for investments across various time periods including 10 years, 15 years and 20 years.
In other words, investors who exited the market during volatile phases, particularly when the returns were negative, to re-enter later ended up with significantly lower returns vis-à-vis investors adopting a buy-and-hold strategy for their equity investments.
