Saturday, June 25, 2011

Equity market – The only way!!!

“The Death of Equity” was the cover article (subtitled “How inflation is destroying the stock market”) in the Business Week which appeared on 13th August, 1979. It said, amongst other things, “For better or worse, then, the US economy probably has to regard the death of equities as a near-permanent condition….” The biggest bull market in the US of all time had already started by the time this howler was read, and lasted upto 2000.

We appear to be at the same stage in our economy. Inflation is causing costs and interest rates to go higher. Although sales growths in the last quarter have been great, profit margins are getting eroded. The future looks bleak with the global economy slowing down and Europe in the mess. Is this too the “death of equities”??

Our equity markets are truly causing us frustration. The markets first reached Sensex level 17000 in September, 2007. It went on to reach the all-time high of Sensex 21000 in January 2008, crash to 7000+ by October of the same year, hover in the same range till March 2009 and then take off to reach 17000 Sensex level by September 2009. In has now been in this range for almost 2 years or to make it worse you are at the same level at which you invested 4 years ago. Further “safe, secure” debt investments are giving us 10% interest. What then is the case for Equities???

India has one of the highest saving rates in the world; however investment into the equity market is abysmally low. Equity markets are equated with risk - and investing in fixed deposits is perceived to be a safe, secure investment, as the capital is secure. However, currency has never been designed to function as a long term store of value. Due to inflation it has always lost value over time.

Warren Buffett personal shareholding fell by $34 million in one day on October 19, 1987. And how much did he lose – zero, because he did not sell. Peter Lynch, legendary manager of the Magellan fund averaged 29% p.a. returns over a 13 year period. However, according to him the average investor got negative returns in this fund in the same period. People lose because:
1. You observe a significant, but temporary decline
2. You mistake the decline as a permanent one.
3. You panic.
4. You sell.

As a long term loaner, you are likely to get about half the returns that a long term owner gets. You are guaranteed (depending upon credit worthiness) to get back the currency that you have lent out. But currency is not purchasing power and the longer the time horizon, the more de-coupled currency and purchasing power becomes. Therefore you have to look for an investment which more efficiently preserves purchasing power.

You have to believe that the twin engines of capitalism and technology will drive superior equity returns. You have to believe that real returns, net of inflation and taxation will build wealth over time. And finally you have to believe that “volatility” will result in temporary declines and a larger permanent advance.

Way to invest in equities:
1. If you need funds to meet a goal over a short term, say upto 5 years, save and invest in debt instruments. If your goal is long, equities are the only way.
2. Invest through mutual funds, as you would be leaving the equity investment, in a tax efficient way, to professionals.
3. Invest through a Systematic Investment Plan, because rupee cost averaging ensures that you outperform your mutual fund manager.
4. Invest with an asset allocation, with only a small percentage in debt. This asset allocation will let you know when to add to equities and when to book profits – without trying to time the market.
5. Believe that there will be periodic big sales. If the declines went away, the returns would go away. Those sales are huge opportunities, if you have not finished buying in the equity market.
6. Even for retirees, systematic withdrawal is an equity strategy for potential growth of income and principal throughout your retirement. But do have one year’s living expenses in a liquid fund, for times of major falls.
7. Our Government has recognized the need to invest in equities by giving tax free returns to holder of equity. Make the most of this opportunity while it lasts.

And finally have a Certified Financial Advisor to guide you through the process.