You can avoid being affected by the current turmoil by staying invested over the long term
A wise man has said that it is the darkest before dawn. And as I look out, it seems pretty dark out there. At the time of writing this, the Sensex is around the 15000 level.
Since it was around 20800 a while ago, most investors have panicked.
And with all the gloom and doom that both international and local media are predicting, I am not surprised. However, let's put things in perspective. The market has come off almost 29% from its all-time high.
The reams of newsprint and thousands of web pages devoted to discussing and analysing the causes thereof can be summarised as under - high oil prices have led to spiralling inflation.
In response, the Reserve Bank of India (RBI) started tightening interest rates and making money supply dearer. So far, there has been no hike in the cash reserve ratio (CRR) but it could be coming soon. CRR is a proportion of the total deposits that banks need to maintain with the RBI.
Higher rates directly affect corporate profitability and earnings. Lower expected earnings translate into lower stock prices and in turn, market fall. This is also known as a cycle in economic jargon.
And a cycle by definition reverses itself sooner or later.
For example, not too long ago, inflation was not high both globally and locally. The interest rate regime was easy and corporate earnings looked extremely healthy. And all this translated into a rising stock market.
Just as this cycle reversed recently, given time, the current cycle too will reverse. All we need is dollops of conviction and patience.
Here's how I think the situation will play out. Oil hitting all-time highs is not a phenomenon that affects India alone. The whole world is reeling. For example, the US constitutes a quarter of the entire world's consumption of oil.
Petrol prices there have already reached $4 a gallon and are expected to inch up. Basic economic theory suggests that when prices increase, demand falls. And lower demand means lower prices.
Experts lament that this basic economic phenomenon will not play out in India on account of the subsidisation of petroleum products. The price that you and I pay for petrol, diesel or LPG despite the recent price hike is far lower than what it would have been had it been left to free market forces.
On its part, the government does not have the political will (especially in a pre-election year) to bite the bullet all the way, leaving the oil companies to bleed with huge losses. And as a population, we continue to consume oil with abandon.
However, one gets the impression that the envelope has been pushed a little too far and this practice of subsidisation of oil cannot last for too long. Elections or no elections, some firm measures will have to be undertaken. More substantial price increases, adjusting taxes on petroleum products and other measures seem imminent.
This is as far as the economics of the fall is concerned. However, one wonders if the fall, as it were, is all that it is made out to be. Here is a perspective. From the level of 20800 in January, we are down to 14750.
Think back a couple of years. In May 2006, the index was at 12612. From that level it sunk to 8900-then too the fall was 29%. But what happened later?
Let's go all the way back to 2001 -the year of the dotcom bust. On Valentine's Day of the year 2000, the Sensex was around 6100. One and a half years later in September 2001, it had sunk to 2680, a fall of almost 56%!! In comparison, the current fall of 29% seems hardly worth a mention.
The lesson here is obvious -market ups and downs are a way of life for an investor. The only way to tackle the same is by staying invested over the long term.
However, if you cannot bear the volatility, you shouldn't invest in the first place. In other words, if you can't stand the heat, please don't enter the kitchen.
A quick look at table A will show you why a long-term investor would be nothing short of serene even during this turmoil.
The value of Rs 1 lakh invested at inception would have grown to Rs 24.2 lakh, Rs 14.4 lakh, Rs 12.4 lakh and Rs 38.4 lakh in the four funds, respectively.
But to earn the above returns, the holding period had to be an average of nine to 10 years. So it follows that those who had the conviction (or had forgotten their investments) have seen their money grow over 60 times.
It is only the frequent coming in and going out (called 'churning' in industry parlance) that spoils the party and the rate of return.
Note that the above clutch of funds is an example. There are several others who have yielded similar results. Also, such high returns may or may not be duplicated going ahead.
However, the point is not to show the precise return on investment but that in order to get such returns, you have to hold on, hold fast, hold out. Through thick and thin.
And if at any time you are consumed by self doubt, remember that in times like these, it helps to remember that there always have been times like these.
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n that they are agents to someone who has 10000 (or more) crores with him stacked in bathrooms, baskets, stables etc. He would offer you a percentage if you helped them in converting their black money into white !
