The last year has been characterized by significant volatility in the equity market and consistent fall in interest rates. High inflation rates have further compounded the challenge to any investor who wants to ensure both security and growth of investments. However, such safe havens are fast diminishing and the latest blow was the budget announcement to tax income from savings over ₹ 2.5 lakh in Provident Funds. All these developments indicate that avoiding equity is now not an option.
The Passive Saver.
There is a sizable majority which is apprehensive about anything other than traditional secure avenues of savings. With reasonably acceptable interest rates one could beat inflation. Also, the encouragement by government for savings through tax benefits helped in developing this approach. This scenario has now changed and there is little incentive for the safe avenues. In the longer run, these safe avenues pose more risk than the seemingly risky options. Negative Real Returns, ie post tax returns less than the inflation rate, means that the value of investment is declining over time. The passive saver therefore relying on limited savings options, oblivious of the effect of inflation, is at serious risk of losing wealth over time.
Why Does one avoid Equity?
Equity by nature is volatile and poses risk along with the possibility of higher returns. Many of us are not comfortable with the idea of seeing the value of our investments going down. And we are also more comfortable with a very slow but predictable linear growth. Basic reason behind this thought being the lack of knowledge about Equity. Investing in equity means partnering in business with associated ups and downs. Majority of the salaried class seeks solace in a secure job with predictable cash flows. This psychology at times is reflected in the investment behavior also where one tries to stay away from any form of volatility/unpredictability.
Why Avoiding Equity is Not an Option?
Investment in equity has some very significant advantages. Foremost is its potential to provide maximum growth as compared to other options. Second important characteristic is its easy and calibrated liquidity. Third is the relative ease of investment facilitated by the fast-developing financial infrastructure and technology. Fourth is the constantly evolving robust regulatory mechanism which is increasingly assuring the safety of investors’ interest. The tax on Short Term Capital Gains is 15% and on Long Term Capital Gains 10% (with exemption up to ₹ one Lakh in an yr). Lastly, the most important reason is that if you want any positive real returns over time, then avoiding equity is not an option.
How to invest in Equity?
There are two prominent methods of investing in Equity. One is to directly invest in listed shares through the Stock Exchanges and the other is through Mutual Funds. For direct investing in shares, one needs to have a Demat Account and Trading Account. Investing in Mutual Funds is far easier. I would personally advise that the bulk of investment in Equity (80% or more) should be through Mutual Funds only. Mutual Funds are run under well-defined regulatory guidelines and provide safety to investors capital. There are different types of Equity Mutual Fund Schemes to suit everyone’s needs and risk appetite. Those with a trading account can also consider ETFs (Exchange Traded Funds). I would strictly advise against being adventurous and trying to indulge in frequent buying/selling under the false notion of timing the market. One should maintain discipline and keep the emotions of Greed and Fear under check.
How Much to Invest in Equity?
Diversification of portfolio is the key to managing Risk and Returns. The proportion of investment in equity should therefore be pre-decided. One thumb rule is to subtract own age from 100 and that would be the guiding percentage. Another method is to keep aside money required for next five years in safe options and invest the balance in Equity. Beginners can start with a lesser proportion and increase it as they develop confidence.
What should be the Mode of Investment?
The best method to invest in Equity Mutual Funds is through Systematic Investment Plans (SIPs). This helps in averaging out the cost over time and induces discipline. Frequent buying/selling is not recommended. One must redeem only as part of a Portfolio rebalancing exercise, or when one is in actual need of funds. It can also be done to roll over Long Term Capital Gains up to the tax exemption ceiling which is presently ₹ 1 Lakh.
Recommendations
- Do not avoid Equity completely. With high inflation and low interest rates, avoiding Equity is not an option.
- Invest in Equity through Mutual funds in SIP mode.
- Decide on the correct proportion in Equity based on risk appetite, age, and immediate financial requirements.
- Avoid frequent redemption of funds other than for purposes of rebalancing and tax benefits.
6 replies on “Avoiding Equity is Not an Option !”
Thank you for the great article. With the changing scenario, the methods of savings need to be altered. The article provides a way ahead for the investment in the equity.
Equity as an investment instrument is a path traversed by very few for its inherent risks as well as mindset of the community at large which has been aptly dealt with in the article. Equity as a viable savings option in the ever changing investment scenario so to even out once has been very clearly listed out in article.
Very informative. Getting financial wisdom through your articles. Thank you
Once again, a well presented and thought out article Rajesh. Completely agree that in this day and age, avoiding equity is not an option. The various routes/forms of investment in equity provide avenues to suit different needs and risk profiles. Starting from a basic MF SIP to MF STP to Secondary Markets to F&O, options are many
The crispness with which this article has been articulated is really commendable. Thanks a lot for guiding me to change outlook towards new mantra of investment. Thanks.
This is a very balanced analysis and sound advice.
Great