Valuation drivers always prevail

What should be a good time horizon to judge your investment performance? Should this time horizon be the same irrespective of where we stand in the market cycle? These are questions that are rarely raised or addressed.

We almost always conclude without reason that one year is a good time to judge investment performance. We judge performance linearly just the same way we assess fixed deposits. But, equity as an asset class is incapable of generating linear returns.

Marketing literature that show high five-year returns always hide the fact that there could have been two or three years when performance was worrisome. Returns could have been lower than inflation or even negative. Recency bias is largely to blame for mistaking equity returns to be linear. If performance was good for one or two years, we forget the times before, when performance was bad. We treat this as inconsequential.

We start believing in new normals. But new normals in equity investing can never be linear. If returns are higher for a while, we would inevitably see time corrections follow. Valuations can alter time horizons and always play a big part in deciding the “how long” and “how much” questions in investment performance.

When the valuations are rich, we may need to wait for a while before we get richer.

 

“The individual investor should act consistently as an investor and not as a speculator.”

– Ben Graham

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