At Equitymaster, we often come across queries like what kind of returns one can expect from the equity markets in the long term. If only, answer to the question was that simple. For the kind of returns one can expect depends upon the time horizon and stock selection skills. And most importantly, investor's behavior. Infact, the latter is so important in investing that there is a separate discipline - Behavioral investing that deals with different aspects of investor attitudes and their influence on investing decisions and returns.
We have the cases of legendary investors like Mr. Warren Buffet or Mr. Peter Lynch who have earned spectacular returns over the years. And then there are retail investors who have burnt hands in stock markets. The latter are mostly the people who get carried away by the bull run, buy at the top of the market cycle and are the first to get out at as soon as a correction takes place. These are the people who become victim to the herd mentality and lack confidence since they base their investment decisions on the basis of popular opinion, regardless of their own analysis about the company fundamentals, valuations and most importantly a self analysis that includes assessment of the risk appetite, return requirements and the investment horizon.
So what explains the success of a few in the equity markets? It indeed requires a much disciplined approach to make gains in the equity markets. To ensure long term returns in the market, it is important to thoroughly examine the earnings quality, management quality and to make necessary adjustments for favorable macro conditions that may make the current earnings look good but may not stay in the future. Once you arrive at an intrinsic value and know that you are not overpaying for a stock, you will automatically be confident about your investments and will not get influenced by any random news that could make you doubt your investment decisions.
Last but not the least; equity investing is inherently fraught with risks and volatility. Despite making right investment decisions, there may be times when a stock does not perform well irrespective of how strong the respective company's fundamentals are. In order to minimize these risks, we believe one should always follow the principle of asset allocation while investing in equities.