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Understanding asset classes (Part II of a three-part series on why should you invest in equities?) In the first part of this series, we discussed that investors who allocate a substantial part of their savings to fixed income are likely to lose out on the higher gains that equities have historically generated over the long-term. Today, we shall take a look at the different asset classes and their attributes in detail. What is an asset class? An asset class is a group of securities with similar risk and return attributes. The following are some of the popular asset classes:
Commodities (gold) Real estate Fixed income instruments Equities or stocks
Commodities (Gold)
Gold is considered as one of the most popular investment avenues in India. There are multiple ways to invest in gold; one can choose to buy “Stock prices will always be far more volatile than physical gold in the form of jewellery, coins or gold bullion. The other cash equivalent holdings. Over the long term, way would be investing in gold-backed securities such as exchange however, currencies denominated instruments are traded funds (ETF). One of the common arguments often put forth by riskier investment, far riskier than widely diversified investors who prefer gold over other asset classes is that they find it stock portfolios” Warren Buffet difficult to handle the short term price movement in the stock market. Such investors fail to understand the thin line of difference between volatility and risk. The real risk is the erosion of purchasing power due to a gradual but continuous rise of inflation. Another argument which is put forth is that gold has shined brighter than the Indian equities over the long-term, but the data suggest otherwise. Since the liberalization (1991), Indian equities have given annualized returns of 15.5% compared to the 10.9% returns posed by gold.
Real estate
Real estate is another popular asset class in India; it involves investing in commercial and non-commercial properties such as apartments and land. Its appeal lies in its tangible nature and social significance, especially in developing countries such as India, where individuals living in their own apartment are considered as financially settled. Investors benefit from regular rental income and capital appreciation of the investment amount. However, all real estate investments require large capital outlay and they are not immune to the economic cycles of booms and recessions. In addition, real estate investments are highly illiquid, offer less scope of diversification and are not tax friendly.
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Fixed income instruments Fixed income instruments include fixed deposits, bonds issued by companies, government and government agencies. Investors benefit from the interest income paid at fixed intervals and at the end of the term the principle is returned to the investor. Fixed income instruments have the lowest risk of losing principle, but have the highest risk of losing purchasing power due to inflation. At present most banks are offering 8-9.5% on one-year fixed deposits.
Equities or stocks Equities are the most popular asset class globally. Investing in equities involves buying shares of publicly listed companies, thereby getting partial ownership of their business and profits. If the business performs well, the profits are passed on to the investors in the form of dividends or capital appreciation. If the business fails to perform, the share prices decrease, and the investors lose their investment value. Suggested readings: ďƒź Why should you invest? ďƒź Why you should invest in equities?
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