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Does equity really benefit in the long run?

Last week I received an interesting query from one of my readers. It said that Dow Jones has moved from 66 to 8500 in about 100 years i.e. a CAGR of only around 5%. Nikkei was around 7000 in 1982 and is at same levels today after 25 years; which means -ve returns considering the inflation. So it is really true that equity gives good returns over long term, as most financial experts advocate (including myself...)? In India the Sensex moved from around 200 in 1979 to 10000 in 2008 i.e. 15-16% returns. But will the next 20-30 years will also yield similar returns?

I think we can look it this issue from four different perspectives.

(1) The probability of making returns from the equity are higher over 'long term' than in the 'short term'. What we mean to say is that in the short term many factors like liquidity, interest rate movements, political uncertainties, natural/man-made disasters etc. may distort the prices from their fair value. These get corrected over a longer time frame.

(2) The shares not some independent thing. They are ultimately dependent on the performance of the company. And businesses take time to grow. If Reliance is getting into Retail, it will take time to make the investment and then the profits will start rolling in. So one has to give time for businesses to grow. Bharti or Microsoft did not become such a big company in one day. Suzlon took about 10 years to become one of the largest wind-power company in the world. Therefore, we should be willing to wait and not expect to double our money overnight.

As regards the examples of Nikkei and Dow, one would appreciate that Japan has been a poorly performing economy of over the last 20 years. US too is a mature economy with very low growth rates. So naturally the corporate performance, on an average, will also be low.

(3) Also, the interest rates in Japan are almost zero and in US 3-4%. One has to look at the returns from equity vis-a-vis the interest earnings. In India the interest rates have been high.

(4) Nikkei, Dow, Sensex etc. are nothing but averages. The averages can sometimes be highly misleading. Individually there would be quite a few companies which would have given good returns. But poorly performing companies in the Index will pull down the average.

I hope this answers peoples' doubts about long-term potential of equity.

Of course, you need to follow some basic rules. If you don't play by these rules, you will not make money. You may have the best car. But if you don't know how to drive, it is not going to take you anywhere. You have to either learn to drive (learn how to invest) or keep a driver (consult a financial expert).


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