Imagine the price of your favourite chocolate when you were a child – and now recall how much it costs today. It’s likely that the price has increased by 2-3 times. Now, how often have you read news reports or heard people complain that “things are becoming more expensive”?
This phenomenon is called inflation, which is the general increase in the cost of goods & services.
For example, if you get ₹10,000 today & keep it under your mattress – you will still have ₹10,000 there 5 years later – but the amount of things/experiences you can buy with that will be lower due to inflation.
Inflation is a defining characteristic of the modern economic system that chases growth, and there is no escaping it. India being a growing economy tends to experience relatively high-levels of inflation compared to more developed economies where the growth rate is lower. The following chart from the World Bank shows how inflation has been in India over the last few decades:
Why Invest?
People invest to grow their wealth – rather than keeping cash, which as we saw, loses its buying power over time due to inflation. Investing puts your money to work & helps generate a return.
At the very least, the goal of investing is to beat inflation, so that your money retains its purchasing power over time. From a practical perspective, a large majority tend to save & invest in order to meet more aggressive long-term goals like buying a house, funding their children’s education, building a retirement fund, etc.
Another common reason to invest for many, especially new investors, is to save on taxes. Taxpayers in India are allowed to reduce their tax bill if they make investments in certain securities as defined under Section 80-C (and its sub-sections).
Ultimately, one should keep in mind what their key objectives are for investing – and only invest in something that helps them meet these criteria. But what exactly can one be investing in?
What are Assets?
Assets are what people invest in, hoping to get a certain return on their investment. Assets that share certain characteristics are clubbed under the same “asset class”. The most common asset classes are:
- Fixed Income: are financial assets that provide a pre-defined fixed return over a certain time period. Fixed Deposits (FDs) are an example, and the most common investment in India
- Commodities: are physical assets like gold, silver, sugar, etc. that are traded and used as a store of value
- Real Estate: are physical assets like land or residential/commercial properties
- Equities: are financial assets that give ownership (or a share) in a company – in exchange for the investment, the investor gets a share in the profits and the growth of the business
The question that now arises is which of the many different options should you invest in?
Each asset class has its own advantages & drawbacks, so it’s important to understand the broad characteristics of each asset class & then determine which one best helps you achieve your investment objectives. Let’s quickly look at each one of them:
Fixed Income
An investment in a fixed income asset has the following key features:
- It gives you a fixed or defined interest income periodically – this can be annually, quarterly, monthly, etc.
- The amount of income you will receive is known (or “fixed”) before you make the investment
- The principal amount which you invest is returned after a defined period of time – this also is known beforehand
The interest income you receive is essentially the rent you are paid for letting someone use your capital (i.e. invested money). In general, fixed income investments are considered to be “safe” because the returns you will receive is fixed & known beforehand. Fixed Deposits (FDs) are the most common investment in this asset class, and also the most common investment in India.
While it’s generally true that FDs are “safe” investments, there’s always the risk of the bank collapsing. If that happens, remember that any deposit account (savings account FDs, etc.) with any commercial bank in India are legally insured up to ₹1 lakh. Which means that if you have ₹2 lakh in you savings account with a bank and ₹2 lakh in FDs with the same bank – you will only receive ₹1 lakh if that bank collapses. Think the PMC Bank scam which happened in late 2019.
But the biggest drawback of FDs is that on average, they don’t even beat inflation!
Gold
This is most probably the most popular investment option in India. It’s a big part of the Indian culture & tradition and associated with most religious ceremonies & social functions. It’s also a common way to save and also pass on wealth to later generations. Gold belongs to the commodity asset class, which is one of the broadest asset class – it includes other metals like silver, platinum, nickel, copper, etc. and even agricultural commodities like sugar, and even orange juice! But by far, gold is the most popular commodity.
The history of gold as investment has an interesting journey, and it’s come very far from its origins as a store of value. Investors globally today view it as a “safe haven” asset – one which people turn to protect themselves (or even profit from) during periods of market turmoil & economic uncertainty. The US dollar & US Treasuries are the only other widely accepted safe haven assets.
Basically, gold is an excellent diversifier to equities – this means that when equity markets go down by a lot, gold either moves up or doesn’t go down by as much. A portfolio that has a mix of gold & equities will generally do much better in market downturns than a pure-equity portfolio. This process is called asset allocation & is an important part of building diversified portfolios.
Equity & Gold returns during market crashes:| Period | 1 July 2008 to 20 Nov 2008 | 5 Nov 2010 to 25 Aug 2011 | 24 Jan 2013 to 3 Sept 2013 | 29 Jan 2015 to 25 Feb 2016 | 29 Jan 2018 to 9 July 2018 |
|---|---|---|---|---|---|
| Nifty-50 | -34.48% | -23.33% | -11.26% | -22.14% | -2.49% |
| Gold | -8.31% | 32.58% | 13.11% | 8.59% | 1.85% |
| Diversified portfolio | -26.80% | -5.43% | -3.39% | -12.54% | -0.53% |
Real Estate
This is perhaps the oldest asset in human history. For centuries, wars have been fought over control of real estate & families have been divided over ownership – such is the allure and appeal of real estate. This physical asset includes land, but also residential & commercial properties. People invest in them because they expect its value to increase over time, and/or also to earn rental income. But we’ll not discuss this in detail here, primarily because:
- Real estate investment requires a large capital outlay, which is beyond the means of most investors, at least at the start of their careers
- It requires very localised knowledge since the market varies from each city & each town
- It’s also considered to be a fairly illiquid asset-class – it takes months, and some times even years, to close on a buy/sell transaction
On average though, real estate has provided approx. 11.7% returns (before tax) which is second only to equities. Note though, this is the average – you might certainly know of instances where someone has earned a lot more – that logic is applicable to unique instances within all asset classes, e.g. someone might have earned a lot more than average on specific equity investments. But the objective here is to identify what are the average returns a normal investor can expect when presented with options to invest in different asset classes.
Why Invest in Equities?
Research & data has shown equities to be the most rewarding asset-class. Yet, less than 5% of Indians invest in the stock market – so what keeps many people away from investing in stocks? Many feel that it’s like gambling & based only on luck. Some feel that investing is only a game for the rich. Yet there are others who feel they don’t have enough to invest. Underlying most of these beliefs for many is the risk & fear of losing money – it’s perhaps the most prominent reason why people hesitate to invest.
But What is Risk?
When people say that a stock is risky, what exactly does it mean? In finance, the most common measure of risk is volatility or standard deviation, i.e. how much a stock/security tends to deviate from its average price. It’s simply a measure of the variation seen in the price of an asset. Equities is generally considered to be the riskiest amongst all traditional assets – fixed income, real estate, gold/commodities, and even currencies.
This is because the price of equities tends to deviate a lot more vs. other assets
There are many reasons why this happens – the performance of a company, current sentiment, broader economic conditions, etc. Basically, it brings with it many uncertainties, and hence it’s riskier.
Equities is indeed a riskier asset class – but it’s exactly why it has been also more rewarding in the long-term. Average equity returns (measured by the Nifty-50) over the last 20 years have been far higher than that of other traditional asset classes people invest in, returning ~14.19% on average where Real Estate gave 11.69%, and gold far lower at 8.72%.
The difference between 14% & 11% might not seem a lot – but it really makes a big difference as it compounds over the long-term. If you had invested ₹1 lakh 20 years ago, then it would’ve grown to approx. ₹14.21 lakhs today with equities, but only ₹9.12 lakhs with real estate & ₹5.32 lakhs with gold!
And here’s the best part: to get that 14% returns, people don’t have to be stock market experts – they can simply invest in the Nifty-50 index and get that returns without knowing much about equities. You don’t need to know about fundamental or technical analysis to get equity returns, you can simply buy & hold the index to get the average equity returns.
If you’re young, then it’s all the more important for you to take advantage of time being on your side – read this blogpost to understand why it’s even more important for youngsters to start with equity investing earlier on.
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Not sure what all you need to know before you get started? Check out our collection of articles specifically written for new investors like you.
