Why equity should be your preferred investment choice

Arun Thukral

Economics defines investment as purchase of goods which will help create wealth in future. In financial terms, it is purchase of monetary assets which will offer regular income in future or capital gains. Thus, the basic presumption for making an investment is that it will be remunerative in future. Now, what is the factor which will decide the profitability of an asset class? It is inflation and the deciding factor is the difference of return offered by the asset class over the prevailing inflation. Any asset class that beats inflation should be the choice for investment and the margin arranged in pecking order would decide the rank for the same. Let us now look at different asset classes available for investments, their performance and future prospects. 

Fixed deposits

Bank fixed deposit currently offer anywhere between 6% and 8% return per annum (pretax)

Gold or bullion

Gold or bullion which mainly is a hedge against inflation in developed nations (as gold is traded in USD in international market)

Real estate

Real estate can mainly be seen as hedge against domestic inflation 

Equities

Equities generally offer 4-5% returns over the nominal GDP growth. Another aspect to be considered is the risk or volatility and liquidity associated with the target asset class. 

Future prospects

The bank fixed deposit is the safest of all the asset classes mentioned above, but the returns offered are paltry. An average annual inflation is around 5%. Thus, the bank deposits offer a pre-tax return of 2-3% over the prevailing inflation, which would not help in creating wealth no matter how long you remain invested. Moreover, the fixed deposit rates are not dynamic in nature i.e. there exists lag effect between the rise or fall in inflation and the change in inflation which is monitored on monthly basis. One can invest in G-Sec bonds to remove this lag effect as the bond market reacts swiftly to the changing inflation scenario in real time; the G-Sec bonds offer a return of around 1-2% over and above the fixed deposits. The corporate bonds offer couple of percentage points more than the G-Sec securities but concomitant risk associated is relatively high. 

Being physical assets, the bullion and real estate act as hedge against inflation — the former is a hedge against global inflation and the latter against local inflation. The local price of bullion factors in the cumulative impact of global bullion price movements and currency movements. 

Among the two asset classes, the bullion offers no income other than value appreciation in case of uncertainty but it has an appeal in the society and is looked up as an asset of last resort in case of emergency. Storage of precious metals in physical format involves cost. Hence, one should buy gold or other precious metals only to the extent needed for consumption.

Being a growing economy, real estate has latent demand. It is an income-generating asset, but the yield differs from location to location. It also requires periodical maintenance or uplift and involves legal hassles, including expenses at the time of letting it out. Over and above, investing in real estate entails huge upfront investment. Hence, the real estate is relatively less investor friendly as compared to equities and bullion, as one can invest in small amounts in these asset classes as and when one has investible surplus.

Physical asset markets are illiquid; these assets are relatively difficult to be monetised at the time of need. The market for both bullion and real estate is opaque and thus lack transparency. 

In equity investment, one is partnering in an entrepreneurial concern. Further, equity investment in listed entities can be started using the systematic investment plan (SIP) method by investing a small amount in the multiples of Rs 500. Equities are traded five days a week, throughout the year, thus offering ample liquidity for one to cash on when needed. And lastly the most important parameter in which equities have an edge over other asset classes is the returns and the spread over the inflation.

Growth potential

Being an emerging economy, the growth potential is abound in India. India houses 125 crore people with rising per capita income and thus it offers a great destination for consumption story. There exists a large gap in the state of infrastructure between the emerging economy like India and developing economy like the US or Europe. India has demographic dividend playing in its favour. India has well educated, English speaking workforce. The working age population (15-64 years of age) represents 65% of the total population and the 29% of the population is between 0-15 years of age. Looking at these numbers, India is in similar spot as US in 1980 and China in 1990s. These factors offer a lot of scope for export-oriented industries given the cost advantage Indian industry can have over the other neighbouring nations. There is enormous scope for building infrastructure in India which offers a business opportunity to infrastructure companies. 

Conclusion

Equities should be the preferred asset class in your portfolio if you intend to retire rich.

The writer is MD & CEO, Axis Securities. The views expressed in this article are his own