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Choosing the path to prosperity

Equity may look risky over short periods; but over 10, 20, or 30 years, it's the only way to earn enough for a comfortable future

Choosing the path to prosperity

Indians have traditionally been good at saving. Remember the good old childhood days when we would put coins in a clay box, often called a piggy bank? That was generally the first lesson in savings in every household. Not to forget, we have seen our previous generations meticulously cutting down their discretionary expenses and focusing on savings. But the problem lies in celebrating a bit earlier. Being happy just with the money lying in your hands or savings bank account would lead to major disappointments in the future. Saving money is only half the job done. To meaningfully benefit from it, one needs to go a step ahead and appropriately invest that amount for it to grow. And at this moment, if you feel proud to have invested your money in a bank fixed deposit, hold on!

Let's take a detour.

Choosing the path to prosperity

FDs are the culprit here. We have witnessed double-digit FD rates in the past, and while it looks good, considering the guarantee it comes with, it isn't so good once you factor in double-digit inflation. Inflation is nothing but a general increase in prices leading to a fall in the purchasing value of the money.

Let us break this down.

Do you buy milk at the same rate you used to 10 years back? Absolutely not! A one-litre packet of Amul milk which used to cost Rs 30 in 2010, now dips your pocket with Rs 58 in 2021. A rise of more than 90 per cent in 10 years!

The future is certainly not any better.

The perils of inflation

  • Most of the time in the past, inflation has been higher or at par with the return on FD. If you consider taxes, the gain on your investments will be reduced further, effectively shrinking your money. This is like a pay cut but doesn't seem to hurt you because of the intangible feel.
  • India has almost always had a high inflation economy. If you had Rs 1 lakh in your cash drawer in 2001, its worth would not be more than Rs 27,000 in 2021.
  • The average inflation over the last two decades has been about 6-7 per cent. For the same reason, history has no story of anyone making it big by just investing in FDs.

Thus, for an intelligent investor, the purpose should not be to save and put it in an FD and feel happy about it. Of course, saving is essential. But the purpose of saving is to grow your money in 'real' terms.

So what's the solution? How can you earn better returns despite inflation?

The only solution is to move beyond the comfort of assured returns provided by fixed-income investments and embrace equity, i.e., stocks.

Say yes to equity
Purchasing stocks means you invest in companies like Wipro, Reliance, HDFC, etc., and participate in their growth journey. Continuing with the cash drawer example, the value of Rs 1 lakh invested in 2001 in Sensex (a basket of 30 largest stocks in India) would have grown to around Rs 16 lakh till mid-2021! This is far ahead of the rate of inflation. Equity is the only asset class that beats inflation hands down over the long term.
Putting together pieces of investing jigsaw without talking about gold would be incomplete, especially in the context of Indians. People's love for gold is not unknown, and the reasons are many. But for investment, equity shines brighter than the yellow metal. Refer to the FD vs. Gold vs. Equity graph to see how someone opting to invest in equity markets instead of FD and gold 20 years back would have been rewarded.

But what about the risk, you might ask. Equity doesn't give guaranteed returns. On the contrary, you can even lose your capital investment. Isn't it?

Well, it is true that equity doesn't guarantee returns and can subject you to sharp ups and downs on a day-to-day basis. But the risk diminishes substantially over a longer time frame of five years or more. Look at the graph titled Equity: Short-term vs. long-term, which depicts this nature of equity markets.

Clearly, equity is volatile and unpredictable over shorter periods of a few months to one or two years. But over a longer horizon, you can be reasonably sure of getting far better returns than any fixed-income alternative. If India grows in the coming years, growth in the stock market is inevitable. Do you have doubts about India's growth over the next 10-20 years?

How to invest in equity

There are two options at your disposal-

  • Direct stock investing
  • Mutual funds

While the end goal is the same, the underlying approach in both the alternatives is entirely different. Direct stock investing is suitable for seasoned investors with sound market knowledge to find and manage worthy stocks by themselves. On the other hand, mutual funds are much more simplified and suitable for both new and seasoned investors who might not be willing to commit the time that goes behind stock picking on their own.

In the subsequent chapters of the course, we will address what mutual funds are, how to choose the right one, and the process of buying them to make your investing journey easier.