Voting or Weighing - What's Your Investment Preference?

"In the short term the stock market behaves like a voting machine, but in the long term it acts as a weighing machine."

That's a quote worth memorizing for every serious equity investor. It upholds a fundamental characteristic of the markets.

Markets generally react to all possible news that can potentially affect the general state of the economy. State election results which were out recently had their repercussion on the market tempo. Parliamentary elections coming up in May 2014 might have its share of impact. Even the global rating agencies have started the prediction game of where the markets could be 5 months from now, based on likely election outcome.

The US Fed has start tapering QE or Quantitative Easing slightly - which is the boost money it released over the last 5 years from November 2008, hoping to kick start the ailing US economy. Maybe in the middle of next year or later, this tapering could gain momentum, which could lead to the markets going southwards.

Inflation index results, RBI rate changes are other examples of news that can potentially affect stock market movements in the short run. More events could come that can about-turn market direction or else boost it in its existing direction.

However as a long term disciplined investor such news and the happy-gloomy faces of the stock market should have absolutely no effect on your investing sentiment. For the plain reason that in the long term, equity investments are expected to reflect business growth of the companies to which the shares belong. Moreover, in the short run markets may tend to spell out the popular companies from the unpopular ones but in the long run stock markets assess the true value of companies. And for most of us investors, stock market is the closest we may ever be to owning a business, and to benefit from its growth.

In the short run, how the stock market values shares is generally influenced by short term news not necessarily relevant to the specific companies you have invested in (through a mutual fund or directly). However in the long run after all the ups and downs, share price of companies are expected to reflect their true profitability and performance.

Have a look at the table below showing S&P BSE Sensex returns over various periods in the last 19 years.

Source: S&P BSE Sensex values from Bloomberg.

*Data for every year considered as on 31^st December, data for 2013 as on 23^rd December

CAGR is calculated as [(S&P BSE Sensex end value/S&P BSE Sensex start value)^(1/no of years)-1]

Past performance may or may not sustain in future

Returns of shorter terms like 1 year and 3 years have seen wide fluctuation. However returns of longer terms like 10 years, 12 years, 15 years are much more stable. This trend is true for the past 3.5 decades of the S & P BSE Sensex’s existence.

As for where the stock markets would go one month from now, 3 months from now etc can neither be guessed accurately nor does it matter, as long as you are a long term investor. This is the reason why SIP makes perfect sense. You do not bother about market levels; just keep investing a certain amount periodically until the long term investment goal has been achieved.

What would a smart investor do? Just stay put. If he was running an Systematic Investment Plan, and the markets are low, he would keep the Systematic Investment Plan. If he had investments stacked up and thought the markets are high, he would lay aside the temptation to redeem and rather keep the investments – unless of course, the goal intended for his investment had arrived. In fact this should be the only reason to exit investments at any time. When the goal has arrived, regardless of what level the markets are at, it will be appropriate to redeem long term investments.

If you have just landed a jackpot and want to invest it for a long period but presently the markets seem to be having a bumpy ride, you could choose the Systematic Transfer Plan (STP) option/plan of any liquid scheme. In STP you leave your money in a liquid fund (it invests in relatively safer debt securities) from where it will be transferred to the equity fund of your choice, little by little, systematically. The process is similar to SIP but you get the added benefit of liquid fund returns, instead of the mundane savings account interest. Some tax might have to be paid since it is considered a sale transaction.

Ultimately, whether your equity investments give you voting machine results or weighing machine results depend on whether you choose to be a stable long term investor or short term chance-taking investor.

Statutory Details and Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.