Allocation to equities is essential to beat inflation, create wealth and maintain or improve your financial health over time
"Salt is what makes things taste bad when it isn't in them" - Anonymous
Salt is essential to life as it is the main source of dietary source of sodium and chloride, both of which are crucial for maintaining health. Apart from providing essential nutrients, salt acts as a flavour enhancer to negate bitter flavours in food. Considering this, it isn't surprising that salt is used globally in various forms for seasoning and pickling.
While the fact that salt is an essential part of diet is quite objective, how much salt should one add is quite subjective. Anyone who has even remotely come across cookery shows and books would be familiar with the instruction "Salt to (your) taste". While the proportion of other ingredients is measured and defined, when it comes to salt, no recipe defines a concrete measurement and dishes out the subjective and oft confused phrase " Salt to taste" or "Namak Swaad anusar" in Hindi.
Ever wondered why cookery books and shows cannot specify exact quantities for salt? The primary reason for this is that everyone has a different preference and palate for salt. Further there is a fine line with salt. Too little of it and food may lose its flavour. Too much of it and food may end up being unpalatable.
Role of equities in wealth creation is similar to that of salt in cooking. Salt in right proportion acts a flavour enhancer. Likewise, allocation to equities in right proportion ensures long term wealth creation. Allocation to equities is essential to beat inflation, create wealth and maintain or improve your financial health over time. Most investors have begun to realize the importance of equities for wealth creation. However, what puzzles many is the question around what percentage of one's portfolio should be in equities. Just like with salt, there is no standard measure of equity allocation that can suit everyone.
While equities are certainly more volatile than other asset classes over the short term, equity returns track/mirror the economic growth of the country in the long term, which in a way explains the SENSEX returns of ~ 16% over the last 4 decades vis-à-vis nominal GDP growth of ~ 14%.
Assumed Investment: - Rs. 100, Assumed Rate of Return: Equity 15%, Debt 8%
As seen above, inverting a 20:80 Equity: Debt ratio to 80:20 results in a 21% (Increase from 158 to 190) and 45% (Increase from 254 to 367) increase in investment value over 5 and 10 years respectively.
The above table is for illustrative purposes only and should not be construed as a promise on minimum returns and safeguard of capital. Equity as an asset class is riskier as compared to debt. Past performance may or may not be sustained in the future.
The "As per taste" dictum for salt translates to "as per risk appetite "(willingness and ability) for equities. Optimal equity allocation is a function of one's risk tolerance, financial goals, time horizon and existing wealth. Investors with longer time horizon, income stability and relatively lower financial obligations can have a higher equity allocation and vice versa. More often than not investors do not invest or invest too little in equities by confusing volatility with capital erosion and end up missing out on their financial goals in the long run.
Tweaking the quote on salt mentioned earlier, one could say that "Equities give a boost to financial planning, when it is in the plan".
The writer is vice president - products & business development, HDFC Asset Management
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