Equity investments can perform the miraculous feat of transforming a bit of your monthly income into capital deployed in a business. Does that sound confusing? Let me explain. Some months back, I came across this statement by John Bogle, the legendary American investment manager and founder of Vanguard Capital, "(Without the equity markets) there would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income." What does Bogle mean by the above statement? How do equity markets 'turn a stream of income into a pile of capital' for an ordinary investor?
Firstly, we have to appreciate that stocks are a unique type of investment when compared to the various kinds of deposits that Indian savers are so fond of. We investors often forget that when we invest in equity, we become part owner of a company. Boiled down to the basics, there are only two ways of investing money: either you can lend it to someone or you can own your own business. Except for buying stocks (and mutual funds that invest in stocks), every financial investment that the Indian saver makes basically amounts to lending money to someone. We generally do not think of it as such, but a bank deposit - even a simple savings account - means lending money to the bank. Similarly, making a PPF or a post-office deposit means that you are lending money to the government.
That leaves having your own business. While starting and running an entire business is not everyone's cup of tea. The existence of stock markets means that any of us can be part owners of a business. We can get a share in the profit stream of a business without the hassle of running a business. As Bogle points out, essentially, your income stream has become part of a pool of capital that is funding a business. Instead of being entitled to just a fixed income on the money, you can - depending on how well you invest - become entitled to profits.
Of course, most of us are more interested in capital gains - stocks gaining price - than in an income stream. Not just that, since capital markets price stocks on the profits they believe the future holds, your investments gain in value based on that, too.
In India, even firm believers in equity - even the committed ones who would be reading our articles - have less exposure to equity than they should have. All Indians need to invest more in equity.
This may sound like a dogmatic statement, but it's actually a realistic one. To appreciate this, one should understand the source of equity profits. The ultimate source of profits in equity is the general growth of the economy. On an average, stocks should grow at a rate that is at least equivalent to the growth of the economy. And the inflation rate is built into the growth of the economy. If inflation is 5 percent and the real economy grows at 5 percent, then stocks, on the whole, could match 10 percent.
And that's just the average. On top of that, as an investor, if you are able to select stocks that are better than the average (for example, through Value Research Stock Advisor), then you can beat the general rate of economic growth by a larger margin.
The fear that people have is that of volatility. The daily noise (I won't call it news) from the stock market is such that the overwhelming impression we get is of volatility. However, this is but an illusion. If you were to look at equity markets once every ten years, you would consider them (and rightly so) the greatest investment in the world.
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