Power of equity investments
Equity is a wonderful asset class to invest in. It's versatile and magnetic, it’s volatile yet calm, it can jangle our nerves on a given day yet it can also empower us to create enormous wealth over a longer period provided we have got our picks right. Here’s why I think equity is the most important asset class in an investor’s portfolio.
1. Turns a pauper into a business owner: Equity means ownership of the business to the extent of the shares held in one’s portfolio. Equity brings ownership of a business to the doorsteps of the butcher, the baker, and the candlestick maker. Even the poorest of the persons can hope to own a slice of a business with the help of equity. No other asset class can do this.
2. Unlimited upside: Generally asset classes have their limitations when it comes to delivering returns. For example, debt returns are closely linked to the interest rates in the economy. Since the returns on equity shares are dependent on the profitability of a particular company, the potential of returns is virtually unlimited as there is no upper limit on the profits of any company.
3. Helps create wealth: Since the returns of equity are linked to the profits of a company, you can make enormous wealth by picking shares of good companies whose earnings grow faster than the general economy. We have plenty of examples of such companies in India.
4. Helps beat inflation over a longer period: The Sensex has delivered a return of approximately 15% since its inception in 1979. Its 10 years, 5 year and even 3-year average returns have been equally impressive. One of the reasons for this is those good companies are easily able to beat inflation with their earnings growth. This translates into higher returns from equity investments over the medium to long term.
5. An opportunity to benefit from the economic growth of the country: There are only two ways to participate in a country’s economic growth from an investment perspective. One, to start a business and second to buy a share of an existing business. Since businesses contribute to economic growth and vice versa, equity is the easiest way to be part of this growth. By buying equity an investor can be in thick of the economic activity without leaving the comforts of his home.
6. Hire promoters without paying them a salary: One of the funny yet realistic ways of looking at equity investing is that it makes you hire the promoters of a company without paying them a salary. Typically a promoter works towards increasing the profits of a company. As profits increase the share price also follows suits (immediately or with a lag) thus making the shareholders benefit. The shareholders either get dividends or see a capital appreciation or a mix of both. Thus the owners work for the equity investors indirectly.
7. Tax efficiency: Equity investments today carry no tax liability if the investments are held over a period of one year, whether one invests directly in stocks or through Mutual Funds. This makes equities a superior investment avenue as compared to Debt, Real Estate, and Gold.
Equity comes with many advantages in the form of potential of returns and tax benefits, yet only 3-4% of Indian savings are invested in equity. The prime reason behind this is that investors are afraid to lose money in equity. One solution for this problem is that we hold our equity investment for a longer period and the second solution could be that we invest in a staggered manner using SIP (Systematic investment plan) and STP (Systematic Transfer plan both of which help us keep the risk at a lower level. The longer-term performance of SIP and STP for most of the funds has been very impressive and has helped investors create wealth. If investors adopt a disciplined approach towards equity investing, they can do a big favor to not only themselves but also the next few generations
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