Even, today, for most investors, Fixed Deposits (FD) seem to be the most preferred avenue to park the funds for short and medium term. Most of these deposits get continuously renewed for long term goals, thereby, getting exposed to the reinvestment risk. At current rates, fixed deposits are not in a position to beat inflation and, therefore, there is a dire need to look at other avenues. Secondly, the income on FDs is taxable, thereby further reducing post tax returns.
Equity is one asset class which can beat inflation in the long run provided one stays invested. But the volatile nature and irregular returns keep a lot of investors away. But just to give you an indication of the kind of returns that have come in this category, one can consider the Sensex, an index representing 30 large companies across various sectors, which has provided a return of nearly 18 per cent in the last 10 years.
But to begin with, investors need to shed their inhibitions and anxieties about equity and try and understand how it works, rather than live with the pre-conceived notion that equity is very risky and equated with gambling. A few guidelines for beginners can help.
First time investors: For those who are keen to add equity in their long term investment portfolio, it is suggested to consider the mutual funds route and invest in large cap diversified equity funds. These funds invest in a portfolio of stocks of large and bluechip companies, diversified across sectors in order to provide lower risk than direct equity. Always remember to look at the past performance of the fund and compare it with similar funds before investing.
The best method of investing is the SIP or Systematic Investment Plan route where you allocate fixed amounts of money regularly every month. The results will not come in immediately and you will need to stay invested and be patient enough to see good returns. Resolve not to stop investing or withdraw if the going in the market gets tough or if negativity persists regarding the state of the economy. If you stay invested during such dark times, you will see better returns when the market sentiment improves.
Investing in direct equity: Today, we have a plethora of information available online on the past performance of equity shares of all listed companies. Since the data is enormous, it is suggested to focus initially only on the index stocks for which you can look up to either the Sensex (30 stocks) or Nifty (50 stocks). Once you have zeroed down on the index, the next step is to find the leaders within the sectors comprising the index. For example, it does not require rocket science to identify, say an SBI or HDFC from the banking and financial sector or an ITC in the FMCG sector.
After you have identified these stocks, start investing a small amount of money initially and gradually increase the allocation as you go along. Please remember that individual stocks carry more risk than a diversified mutual fund, but at the same time can outperform the mutual fund during good times. Stocks also provide dividend income which is tax free for the investor. In fact, some of the large companies in the FMCG and pharma sectors, including many public sector giants like ONGC, dole out huge dividends which act as an additional income.
Equity aids long term wealth creation and is one of the best asset classes which reward the patient investor. The earlier you begin investing, you will have more time to let equity perform and deliver. If you decide late in life to enter into equity, the time factor may not support you since your goal may be very near. Monitor your portfolio on a periodic basis and avoid checking the values on a daily basis as wealth creation is a long term process and nothing will change in a matter of a few days.
So, take an informed decision and consciously try to include equity in your asset allocation to achieve your long term goals.
The writer is Chief Planner, Proficient Financial Planners