This my sixth article on the nuanced concepts of investment risk for life insurance salespersons. You can read all my previous articles and more in my Blog www.helpindiainsure.iistpune.in. The articles on investment risks are a available on this page link in the Blog https://www.helpindiainsure.iistpune.in/category/finance-for-life-insurance/. Life insurance salespersons will sell ethically and correctly, if the concepts of investment risks are understood. Each of the articles so far and the subsequent ones to follow will explore the concept of investment risk in all its nuances.
We also undertake the course Finance for the Life Insurance Sales Professional (FLISP). Click on https://www.iistpune.in/finance-for-life-insurance-sales-professionals-flisp/
Introduction
You are often confronted with data on how well stocks or mutual funds performed in the past. This is then extrapolated into the future, and a rosy picture emerges. One of the most common baits is that the SENSEX was 100 in 1979 and today it is at about 83000. You are told that if you invested Rs. 100 in 1979 in a SENSEX Fund, today that would be worth Rs. 83,000. That is quite a growth. No wonder many people fall for this line of argument. Reality is quite different from such simple extrapolations! Take the sinking of the Titanic ship for example.
The Titanic Loss
You may have heard of the Titanic ship. The ship crashed into an iceberg and sank. Almost everyone on board perished in ice cold waters. Here is what the Captain of Titanic had to say a few years before the ship crashed into the iceberg[1],
When anyone asks me how I can best describe my experience in nearly forty years at sea, I merely say, uneventful. Of course, there have been winter gales and storms and fog and the like. But in all my experience, I have never been in any accident… or any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort. – E. J. Smith, 1907, Captain, RMS Titanic
In 1912, five years after the Captain had boasted, the Titanic ship sank. Past performance is no indicator of future performance. The future is a standalone subject.
An example of past return and future return
Most analysts take a figure and project it to calculate future returns. For example, a mutual fund gave an outstanding result of 15 % in the previous year. Analysts will take this figure and show you how if you earn 15 % year-on-year for the next 15 or 20 years, you will be a very rich person. In 20 years, your money will multiply more than 16 times at 15%! This is unrealistic. The money that you have invested goes through many ups and downs in the market and at the end of it the chances are you will (if lucky) get around the normal return of savings in the economy.
Let us take an example.
A case where past return did not reflect future performance
Before you get into reading the content below, I would like to inform that this is not an isolated case. There are numerous such instances in higher risk investments.
Table 1
Reliance Industries
Average of the quoted share prices during the year[2]
| Year | Share Price (Rs.) |
| 2005 | 220 |
| 2006 | 318 |
| 2007 | 720 |
| 2008 | 308 |
| 2009 | 545 |
The compound annual growth rate as reflected in the data in Table 1, for the period 2005-2009, is 19.89 %. This is an impressive rate, despite there being a major stock market crash in 2008. Now suppose you take 19.89% as the projected rate of earning over the next 5 years. The share price should have been as given in Table 2.
Table 2
Reliance Industries
Projected share price at CAGR 19.89 %
| Year | Share Price |
| 2010 | 653 |
| 2011 | 783 |
| 2012 | 939 |
| 2013 | 1126 |
| 2014 | 1350 |
If we go by the belief that the future will play out as per past performance data, then in 2014, the share price of Reliance should have been Rs. 1350. But what was the actual market performance of Reliance Industries? See Table 3.
Table 3
Reliance Industries
Actual share prices 2010-2014[3]
| Year | Share Price |
| 2010 | 529 |
| 2011 | 346 |
| 2012 | 420 |
| 2013 | 448 |
| 2014 | 446 |
Your advisor, in 2009, would have typically told you that your money will increase by 2.5 times in just 5 years (from Rs. 545 to Rs. 1350) if you invest in Reliance Industries. Five years later in 2014, the share price was actually Rs. 446 as compared to the share price of Rs. 545 in 2009. Forget earning nearly 20 % CAGR annually, your wealth would have turned negative in 2014 compared to 2009. You would actually have made losses. Titanic losses.
[1] https://www.quotes.net/authors/E.+J.+Smith,+1907,+Captain,+RMS+Titanic
[2] https://www.learnstockmarket.in/share-price/reliance-industries/#0-reliance-industries-share-price-history
[3] https://www.learnstockmarket.in/share-price/reliance-industries/#0-reliance-industries-share-price-history