What Is The Best Investment Of All?

“Mirror, mirror on the wall

Who’s the fairest of them all?”

The old fairy tale put a relative or comparative measuring tool in the minds of kindergarteners. We grow up with a competitive frame of mind and a desire to outperform. Superior performance is the primary desire of an investor as well even while doing asset allocation, choosing safety of some investments and risk in others.

While traditional wisdom, possibly as old as the Snow White story where the Evil Queen asks “Who is the fairest of them all,” says that high risk is linked to high returns. The Guru, Warren Buffet however says, “High returns with low risk is the key.”

This is true and applies to most asset classes. The speculative element in us, driving our investments pushes a good part of our investment towards the short-term momentum opportunities, buying when securities have run up, in the expectation that there will be others willing to pay a still higher price. The classic “Greater fool principle” that pops up at regular intervals and dies out as markets correct.

So where does one find the ‘fairest of them all?”

Oft repeated tales say that of commonly accessible investments, the best asset class is equity. Debt is considered fine for the risk averse, boring, nearly ignorant and old-fashioned investor. And so it is in times of excitement in equity markets. At normal times, when the frenzy gives way to entirely avoiding the equity markets over long periods of time it is interesting to see which asset does better.

Ben Carlsson, in a brilliant analysis of “16 Unbelievable Facts About the Market” in his blog “A Wealth of Commonsense” shows that for “the period ending in March 2020 saw long-term bonds beat the U.S. stock market for 25 years.” This relative performance of the assets in the US is nearly mirrored in India. Our data does not stretch as far back as in the US, but we can compare equity with fixed-income for 25 years. Between 1994 and 2019 the G-Sec Index and Corporate Bond Index both outperformed the Nifty.

The story changes in 2020, and into 2021. Between 1994 itself that saw an equity market boom in the early months, 1999-2000 had an equity boom. 2002-03 to 2007-08 saw a golden 5 years for equities that saw the Nifty grow 7-fold. A 700% return in 5 years!!! Yet, with the booms came crashes and the staid old workhorses of the Government Security and Corporate Bonds came out ahead as the tortoise did in its race with the hare in another story from our childhood.

So how does one get the best of both worlds?

Harry Markowitz who, along with William Sharpe and Merton Miller was awarded the Nobel Prize in Economic Sciences in 1990, said of his personal asset allocation, ”I should have computed the historical co-variances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it–or if it went way down and I was completely in it. My intention was to minimize my future regret. So, I split my contributions 50/50 between bonds and equities.” (https://jasonzweig.com/what-harry-markowitz-meant/)

So, the takeaways from Ben Carlsson, Harry Markowitz and data suggest

• Diversification between asset classes.
• Exit, even if gradually from heated, very popular equity when they boom into sedate bonds to earn a good return and to keep powder dry to buy equities when they are in the gutter.
• Ignore debt markets at your own peril.
• Understand your own risk appetite and do not invest based on templates.

(This article is modified from a previously published piece in blog.thefixedincome.com, written by this author)