Most of us remember the mutual fund commercials which end with those fast disclaimers “Mutual funds investments are subjected to market Risk”.
However, most people aren’t aware of the fact that their so-called ‘safe investment’ options carry risks as well. Bank deposits are guaranteed up to 1 lakh rupees. Corporate FDs carry default risks as well. The only additional risk associated with a mutual fund is the price risk, which also accompanies everything that has a market price of Real Estate or Gold.
Why has it traditionally been considered risky?
There is also the possibility of suffering losses because the profit that the investor is going to make is entirely based on the market price of the share, which varies from time to time. The industry trends, the economy and inflation will have its effect on the company and its shares. Additionally, the company’s CEO, management team and the way they manage their finances can make or break the value of the company’s share.
It is true that equity investment needs lots of research for best returns, it is difficult to make equity investment decision for the individual. Now we have a great option of Equity Mutual Funds where fund managers do all research and investment on behalf of investor for a very small amount of fees.
What makes it no longer risky?
Equity investments have been considered risky due to the fact that it has always been associated with the volatility of the stock markets. But the truth is that investing in equity can not only give you high returns but also be less risky in the long term when compared to other forms of investments. How is this possible? When the value of the shares keeps fluctuating and the stock market is highly volatile, leave alone high returns, how can it even promise safe returns?
To answer this question, we need to understand a thing or two about stock markets and their volatility. As we say, “Beauty lies in the beholder’s eye”, stock market volatility can be perceived differently on different instances. While it is true that stock markets are highly volatile, the volatility becomes an issue/risk only when the market is tracked on a day-to-day or monthly basis. What happens when we track on a day-to-day or monthly basis? There will be many ups and downs. In the case of a short term, these ups and downs will hit the investor hard and negatively impact their chances of safe and improved returns. But in a long-term investment, these everyday ups and downs wouldn’t matter. The volatility does not impact the investment.
Imagine a reservoir being filled by the rains and its tributaries. The outgoing water from the reservoir feeds lands downstream. If we were to check the water level every other day, it is bound to fluctuate. But if we were to check it after a year a two, the level would be quite high. Reason: inflow of rain water during monsoons would have been at the peak, winters would have required less release of water, summers would have drained more water. These ups and downs would have mattered a lot if we happened to keep checking the water level frequently. But in the long run, the ups and downs would have negated each other and balanced out. What we get to see at the end, is the well-maintained minimum pool level or probably more than that.
Also, in the long run, the investment made in equity shares increases in value by sharing in the growth of company profits. This is one of the biggest advantages of equity investment.
The table below shows the risks associated with equity investments made in the month of April of each year from 1979 to 2015. The risk associated with the investments made on 3 April 2015 seems to be fluctuating over the years.
The investment made in 3-Apr-1980 yielded an average return of 26.85 on 3-Apr-2015. This is quite a high return compared to the 3.92 it would have yielded on 3-Apr-1980. Although the market kept fluctuating all through these 35 years, at the end this long-term equity investment did prove to be a safe one, offering safe & higher returns.
The investment made on 3-Apr-1984 yielded an average return of 20.77 on 3-Apr-2015. Over a period of 31 years, the long-term equity investment has earned quite a return, but still less than the 35-year investment that we considered in the previous case.
The investment made on 3-Apr-1998 yielded an average return of 17.81 on 3-Apr-2015. Over a period of 17 years, the long-term equity investment has earned a safe and high return. Terms longer than 17 years have yielded even better returns, as depicted earlier.
This should conclusively prove that Equity investments are not risky in a longer term.