Ladder7 Financial Advisories
Investors are fed up with equities these days. Equities have been particularly dodgy in these past almost six years. Many rue their decision to put money in equities at all.
They all feel that they might have been better off investing in simple FDs. One investor had actually told me that he would have earned about Rs.3 Lakhs a year from his portfolio of Rs.40 Lakhs.
He was upset that over a five year period, he could have actually earned between Rs.16-17 Lakhs, whereas he had earned less than half that, with his equity portfolio. There are other investors, who are even earning negative returns, depending on the timing of their investments.
Should they have invested in FDs?
On the face of it, it appears like a no-brainer. But FDs are instruments that offer fixed but low returns ( after adjusting for taxes ) . Also, they would not beat inflation. The risks are low however.
By investing in FDs you are ensuring low returns. That means if you invest predominantly or all of it in FDs, your corpus will lose it’s value in real terms, after adjusting for taxes and inflation. This will work only if the corpus is really big, like say Rs.4-5 Crores and your expenses are not too high.
But most of us don’t have corpus that huge and need real return from our portfolio, to make it last in the retirement years.
But, atleast I would have earned my 7-8%...
That’s the point. The investor would indeed have earned that but has foregone the opportunity to earn a real return after inflation and taxes! Is earning even less after investing in equities fine then? It is not.
But let us for a moment look at equities. It is essentially an infinitesimal portion of the business itself that one owns. Sound businesses will be able to earn reasonable profits.
But the profits themselves can fluctuate over time based on economic factors, which means there is a risk of variability of returns.
Also, since equity represents ownership of a portion of business, there is no fixed return that one can expect from the investment. Everything would depend on the performance of the business itself.
However, to compensate for these, equities do offer the prospect of excellent returns when the going is good for the business. Such returns can compensate for even periods of prolonged underperformance. When prospects are good, the stock prices rise to reflect the premium that other investors are willing to pay for the performance.
Apart from this, the investor will also be rewarded with dividends. If the investor has invested long while back, the dividends can be substantial in relation to their original investment. Good companies offer 100% or more on the par value of the equity share. These are investors who would reap the benefit of staying invested.
They can also benefit from the appreciation, if they would like to sell off, at some point. Hence the returns in equity is through returns arising out of the business ( dividends ) plus appreciation of the share price.
On the flip side, equities can go down too if the economic prospects dim ( like the current moment ), competition catches up, regulatory burdens increase, cost of doing business goes up due to different factors, the product/ category the company deals in becomes obsolete etc. Hence, there is a clear risk in investing in equities, which the investor needs to understand.
Subject to this, equity is a very good investment option for those who want high returns but are willing to stomach volatility. This has been borne out in the past. Equity investments have always outperformed every other asset class over time.
Today investors keep saying that they have got very poor returns in the past six years. That is true. But that is the inherent uncertainty in equities. This is not the first time that equities have been range bound. The Sensex has been in the 3000+ range between 1994 to 2003, barring one year in between when it went to 5000+ range. We all know what happened to Sensex between 2003-2007. That made up for a decade of poor returns.
Asset allocation is important
There is no gainsaying that all investments should have been done in FDs. An investment portfolio should be constructed in such a way that the different assets constitute the portfolio in the required proportion. These assets would have different risk-return equations, liquidity, tenure etc., which is what makes the portfolio robust, as different portions of the portfolio perform at different times.
It is always good to have such a mix as it is very difficult to predict when what will perform. Most investors think they can time the entry and exit in various instruments, which is a fallacy.
Timing the entry and exit is a bigger risk as one can actually get hit both ways! Moving from one asset class to another based on what is performing at the moment looks great, till another asset starts performing.
Then one needs to move again. This may not be possible always and lots of times comes with wrong timing risks ( buying well after the rally is underway ), costs associated, taxation etc. After all this, the portfolio may not be positioned to meet the goals it was designed for, in the first place.
Investing and staying invested
An investment is done with some view in mind. It is never investment for investment’s sake or with the motive of getting maximum returns. The investment mix should assist in meeting their cherished goals. A portfolio put together properly is a potent ally for the investor.
The investor could somewhat alter the allocation towards and asset class by 5-10% on a tactical basis, based on near term triggers. Unbundling the portfolio itself and running in any and all directions, would be courting disaster. Many of them do. I really hope you are not among them.