MarketSmith India INDIA
December, 2016
Why should you invest in equities? (Final part of the three-part series on why should you invest in equities?) Equities have earned their reputation of being a roller coaster. They have taken investors on a bumpy ride time and again, and yet have proved to be the best performing asset class in India in the long term. This is due to a number of reasons, let us discuss a few important ones:
Unlimited upside potential
Take the case of Mr. Happy Singh, a software engineer working for an MNC. As an employee, he gets a fixed salary every month, a quarterly bonus for good performance, and yearly salary hikes. He keeps a part of his savings in a bank in the form of fixed deposits. The bank deposits and his fixed salary provide him with the financial stability that most individuals desire. Despite all this, Mr. Singh’s upside potential is limited; his salary or interest income is not going increase significantly even when his company or his bank performs exceedingly well! Now compare this with a more effective recourse - investing in equities. If Mr. Singh purchases shares of a firm, he simply becomes a part owner of that firm and thus gets a right to claim over its future earnings! Hence, equity investors are rewarded handsomely for taking on higher risks, which is not true for other asset classes.
Upbeat Returns
Another valuable attribute of equity is its ability to generate high returns over the long term. For instance, over the past 20 years, the Sensex has increased at compounded annual growth rate (CAGR) of 12%. This means that if Mr. Singh saves a sum of INR 1 lac with a bank in the form of fixed deposits for 20 years, his savings would get compounded at 8% p.a. and he would receive a corpus of INR 4.66 lacs at maturity; whereas, if he invests the same amount in equities for the same duration, he can earn returns at 12% p.a., which would turn his investment into a corpus of INR 9.65 lacs! Additionally, if Mr. Singh takes the help of an expert stock picker, the expert would use his stock-picking skills to pick winning stocks and outperform the index. If the expert manages to earn even 2% more than the index, Mr. Singh’s corpus would amount to staggering INR 13.75 lacs!
Scope for diversification
Let us assume that Mr. Singh decides to invest in the Indian stock market. He invests his entire savings in just one stock that is his most promising pick. Even though the stock may provide promising returns over the long run, its price would probably fluctuate in the short run. In case he wants to sell his stocks on a particular day to meet certain expenditure, chances are high that its value may be down on that particular day. This is precisely the reason experts often advise investors to diversify their portfolio as it reduces both portfolio volatility and overall risk. A well-diversified portfolio contains a variety of stocks that react differently to market forces such as regulatory changes, interest rate movements, and currency fluctuations. Equities provide investors with a high scope of diversification, compared to gold and real estate. Investors can put a small amount of money in a number of stocks depending upon the capital invested.
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MarketSmith India
December, 2016
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Tax benefits Equities are tax friendly as well. Long-term (greater than one year) capital gains on equities are exempted from income tax, which means that Mr. Singh can earn his salary, pay tax on it, invest it on equities, and still not be liable to pay a penny of tax on gains arising from the investment!
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