To get average returns from equities, one has to average returns over many yearsWhen stock markets go through turbulent times, many investors give up. The tendency to push the ‘exit’/’sell’ button is very high during such periods. But let the market change its mood, and the same investors sing praises. This is classical human behaviour. Most investors like to follow a herd. When the going is good, most investors come to the market expecting 12-15% annual returns. When such returns don’t arrive, they get disappointed. Very few are actually willing to sit through thick and thin.

The important thing that most investors do not understand is that 12-15% returns do not happen in a straight line, like in case of a bank FD. To get average returns from equities, one has to average the returns over many years, says Rajeev Thakkar, chief investment officer & director, PPFAS Mutual Fund. In his annual note to unit holders, Thakkar has explained the reason behind why the minimum investment horizon in equity funds has to be fairly long.

Average return explained

When you ask any equity investor, advisor or fund manager about projected returns from stock market, they usually mention a range like 10-12%, 12-15%, or 15-20%. This number, they often say, is the average return from equity. For investors, such return projections serve an important purpose. It sets their expectation. So, you can expect those returns. But, these are average returns. In the last 20 financial years (March 31, 1998 to March 31, 2018) the Nifty 50 Index has given a return of 11.65% p.a. on an average.

However, good luck to anyone wanting a similar return over any one year period! If you are expecting 12-15% returns in a year, you will be majorly disappointed. This is because the average works only when you are invested for a number of years.

Thakkar has done some data analysis. In the table below are the one year returns on Nifty and Sensex over the last 20 years.

The interesting point is that only in four financial years out of 20 namely 2017-18, 2010-11, 2006-07, 2004-05 have returns been anywhere close to the average returns.

In all other cases, the returns have been all over the place.

Returns over the years

Financial year Nifty 1 year return % Sensex 1 year return %
2017-18 10.25 11.3
2016-17 18.55 16.88
2015-16 -8.86 -9.36
2014-15 26.65 24.89
2013-14 17.98 18.85
2012-13 7.31 8.23
2011-12 -9.23 -10.5
2010-11 11.14 10.94
2009-10 73.76 80.54
2008-09 -36.19 -37.94
2007-08 23.89 19.68
2006-07 12.31 15.89
2005-06 67.15 73.73
2004-05 14.89 16.14
2003-04 81.14 83.38
2002-03 -13.4 -12.12
2001-02 -1.62 -3.75
2000-01 -24.88 -27.93
1999-2000 41.78 33.73
1998-99 -3.48 -3.92

Averages are built over years

A simple point which gets ignored by equity investors is that to get average returns from equities, one has to average the returns over many years. One cannot hope to get the average returns in any one particular year.

An investment horizon of 10 or 20 years is not a silver bullet or a magic potion curing all ailments.

If you look at the average returns of Nifty & Sensex, it all starts making sense. For instance, the 20-year average return is 15%. The 10-year average return is 11-20% (there are two 10-year periods).

This data shows us something very important: averages are built over many years. Just like you cannot expect a batsman to score his average of 50 runs per innings every match, it is unfair to expect equity markets to deliver average 12-15% returns every year.

If you want to get close to the average, stay invested for a longer period of time.

An investment horizon of five years reduces the chances of negative returns and even the magnitude of negative returns, says Thakkar.

In the case of rolling five year returns over the last 25 financial years, the number of negative periods fall to 2 out of 20 and even in those two periods, the maximum negative is 2.62% per annum as compared to negative 36% annual return.