Get Real about the Historical Performance of the Sensex

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July 14, 2012

If you listen to your broker or financial advisor, they will always tell you that the stock market goes up over long periods of time. Although there is some truth to this advice, the reality is always somewhat more complicated. If you had been unlucky enough to purchase the Sensex at its most recent 21,000 peak on November 5, 2010 you would have lost (18%) of your money as of Friday’s (July 13, 2012) close. It appears that Friday the 13th is particularly inauspicious for Indian investors. Although two years is not particularly long-term, it’s a long enough time period to begin questioning how long it will take to get back to the prior highs. The under-performance of the Sensex is further compounded if we calculate the real (inflation-adjusted) return. A lot of journalists and financial pundits usually ignore real (inflation-adjusted) performance because its difficult to calculate. Unfortunately, by ignoring real returns it doesn’t make the loss of purchasing power from inflation any less real.

Inflation is a stealth tax on investors. Even if the market is up 20% but inflation was up 25% over the same time period your actual return in terms of purchasing power (the things you can actually buy) is negative (5%). You are actually worse off even though the stock market was up 20%. Furthermore this analysis doesn’t even include the negative impact from taxes.

The chart above plots the performance of  the Sensex beginning in April, 2005. I chose the starting date based on the earliest available WPI data using the revised 2004-05 base year. The blue line measures the Sensex in nominal terms, which is un-adjusted for inflation. The annualized return for the Sensex was a respectable 15.2%, even with the major bear market in 2008. Unfortunately, if we adjust for inflation we can see that the results are still positive but not as impressive. The real inflation adjust annualized return for the Sensex was 8%. The main lesson to be taken away is that investors need to be cognizant of inflation, especially those of you saving for retirement. What matters most is maintenance of your purchasing power.

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