Equities allow investors to participate in economy's growth potential

Today, equity has become a default investment choice if you want to invest for the long term. It is estimated that over the longer time frame equities generate the best risk–adjusted returns. In case of longer time spans of, say eight to 10 years, the downside risk for equities is almost negligible, assuming that you do create a good quality equity portfolio.

Sensex's performance over the last 40 years

The BSE Sensex was at a level of 100 when it was launched in 1979. Over the last 39 years, the Sensex has moved up from 100 to over 38,000. That means if somebody had put Rs 100 in the Sensex in 1979 and forgotten about it, it would be worth Rs 38,000 today. That translates into a compounded annual growth rate (CAGR) of 16.45% per annum. We are not adding the dividend yield on the Sensex, which has averaged around 1.50%, taking the overall CAGR returns on the Sensex to 18.95% per annum.

But has Sensex beaten other asset classes in India over the long run? We looked at data about returns from different assets class such as bank FDs, debt mutual funds and equity funds (equity funds have been used as a proxy for equities, since that is a much better diversified portfolio that retail investors have access to). The data showed that only equity as an asset class has conclusively beaten inflation over the last 20 years. If Rs 1 lakh was invested in each of these over 20 years, the returns are as follows: FD-Rs 3.38 lakh, debt MFs-Rs 5.11 lakh, equity MF-Rs 13.74 lakh.

Even if you look at asset classes in the US markets, it is equity that has given the best returns. We looked at returns from global assets classes over the last 200 years. In fact, the returns on equity on an annualised basis is nearly twice that on bonds. The returns between January 1802 and June 2013 for US assets were as follows: equities-6.6%, bonds-3.5%, T-bills-2.7%, gold-0.6% and dollar-1.4%.

Equities have created more wealth than any other organised asset class, not just in India but across the world. We are currently talking about just investing in the index and forgetting about it. If you add the fact that there are smart stock pickers and fund managers who do specific stock selection and manage to beat the index, then equities look a lot more attractive as a means of wealth creation. So what makes equities the best bet to create wealth in the long run? Actually, there are five reasons for the same.

Why equity is the best performing asset class

Equities represent a share of the company ownership and therefore participate in the growth. As a shareholder, you are the fractional owner of the company. While the risk is higher in direct equity investing, this is very important for a growing economy like India. You are able to participate in the upside potential in the market much more effectively compared to other asset classes.

Equity investing ensures that the power of compounding works in favour of the investor. When you stay invested in equities for a long time, the intermittent returns on the equity are also reinvested into the same stock.

Equity as a concept has always favoured time over timing. No point looking for tops and bottoms in the market as they are hard to predict. It does not matter whether you invest at market highs or market lows. As long as you invest consistently in quality equities in a disciplined manner, you are likely to generate wealth. You basically combine the power of compounding with the power of rupee cost averaging.

Equities benefit from a variety of factors like changes in macro factors, changes in industry level factors, changes in global trends, etc. Over a longer period of time, the positive impact of macros tend to outweigh the negative impact. This is more so because a higher level of GDP growth and government enforced inflation control tend to benefit equity shareholders a lot more.

Equities are theoretically riskier than debt, but it is possible to manage this risk. In many ways, it is difficult to manage risk in bonds or money markets. They are largely out of your control. Same is the case with currency investments also. On the other hand, equity risk can be managed in a number of ways. Investors can reduce the risk in equities by diversification across stocks, sectors and themes. Investors can reduce their risk by researching and constantly evaluating the stocks that they are holding. Finally, there is the mutual fund route available for investors who do not have the time or capacity to track equities on a daily basis.

The writer is chief sales officer, Angel Broking