Many investors shun equity completely to avoid risk. All who do so run the risk of having their returns eaten up almost entirely by inflation. Equity investment does come with risk, with high short-term volatility, but no one should invest in the stock market for the short-term and no one has good knowledge of stock market risk & returns. It’s a long-term investment that can deliver sizable returns, greater than even property while offering high liquidity. The two most common ways to invest in equity are through the stock market and through mutual funds. Let’s understand which one you’re more suited to.
Is stock market investing for me?
You can make lots of money investing in the stock market. Ask anyone who invested in Infosys in the early ’90s or Reliance in the ’80s. There’s so much money to be made that a salaried professional would wonder why he doesn’t give up the 9-to-5 and just invest in equity. But there’s a catch, of course. Stock market investment takes skill, effort, and time, failing which, you could end up losing a lot of money.
Traders vs investors:
People who invest in the stock market can be divided into two types: traders and investors. Traders seek to make a profit from the difference between today’s and tomorrow’s prices. This takes special skills and is also time-consuming and risky. An investor, on the other hand, does away with short-term fluctuations by staying invested for the long term.
While trading is surely not for most people, long-term investment can be considered by those willing to put in the time and effort it takes to study companies’ fundamentals and technical indicators of growth. As you’re doing it all on your own, you keep the gains entirely (minus what you pay a broker, for a Demat account or in tax, if any).
Is mutual fund investment for me?
Mutual funds offer most of the gains of the stock market — at a small price. Instead of learning about the market and the following sectors/companies, you simply pay professional investors to grow your money. You continue with your life and job while your money grows along with the market. The money you invest is pooled along with the funds of millions of others like you to create a fund (hence, a mutual fund).
If you’re the type of investor who doesn’t like a risk but understands the risk inherent in safer investments, equity mutual funds are a good way to get going with this asset class. For a small fee, your money is managed and growing.
Diversification:
Moreover, mutual funds allow diversification within the stock market. Whereas you’re risking your money on one particular company when you buy shares, a mutual fund is a pooled investment. One mutual fund will have investments in several stocks. So if one company has a poor quarter or gets bad PR over a year, your money is not fully exposed to it. For example, when Satyam’s stock crashed, their shareholders would have lost a lot, whereas mutual fund investors would not lose much less.
To put it succinctly, therefore, stock market investment is for those with an understanding of the markets and the time to keep track of how a company is performing. Mutual fund investment requires less specialized knowledge and involves less effort.
Should I be investing in equity at all?
Since you’re wondering whether you should invest in mutual funds or the stock market, we’ll assume you’re new to equities altogether. In case you’re still wondering about the stock market risk & returns, here you should know about some benefits of mutual funds.
Tax benefits: Equities are the most effective instruments from the perspective of taxation. Dividends are exempt from tax. Dividend Distribution Tax is not applicable. There is no capital gains tax if held for a period of one year. Even short-term capital gain is subject to a flat rate of 15%. The rules are the same irrespective of direct investment in equity or through mutual funds.
Beats inflation: The good part of investing in equities is that they give inflation-beating returns (on a conservative basis) over the long term. The guy who is running the grocery store may be making more money than the young software professional. That is because the returns are much higher in business. In most cases, even if the investment is made at high valuations, but in good stocks, the investor earns a decent return over the long run. On the other hand, your average FD offers returns that leave you worse off after tax. This may be a bigger risk than the risk involved in equity investment.
No interest rate reduction risks: Sure, equity has its own risks, but mostly over the short term. On the other hand, with non-equity investments, you run the risk of interest rate reduction. Economists tend to reduce interest rates so that businesses can flourish. Have you realized, though, that all your fixed-income instruments, such as post office savings schemes, fixed deposits, and bonds all have lower yields as a result? And if your FD matures when interest rates are at 5-6%, your money doesn’t even keep pace with inflation. Equity mutual funds may give poor returns over a couple of quarters, but over the long term, you’re very likely to see double-digit returns.
How long should I stay invested?
The most disturbing reason for investing in equity is investor desire (or ‘greed’) to make quick profits. Equity investments are the best asset category for building wealth, but they are no “get rich quick” solutions. You may get ‘tips’ from so-called experts, but if you think that a stock or mutual fund will double or triple in a few days, get it out of your mind quickly. Equity investment is for the long term. If you have a financial commitment for the next 5 years, it is preferable to park the money in debt. Equity is strictly for long term investors and has stock market risks & returns. The technical definition of long term is more than 10 years. For those not in it for the long haul, equity is the best choice.
Who should invest in Equities?
Almost everybody can invest in equity. The only exception is a person who needs money in the short term. If there are financial goals falling due within the next 5 years (retirement, children’s education, etc), it is preferable to move investments (or at least a large portion) into debt.
How should one invest in Equity?
To tackle the various risks associated with equity, such as the study of the business, valuation of such business, etc it is highly recommended that professional help is taken. The JamaWealth.com Equity advisory is one such service.
Whether it is equity or equity-oriented direct mutual funds, investment in equity should be for a time horizon in excess of 5 years. Of course, mutual funds allow the flexibility to liquidate investments any time, but the realization of financial goals can happen only by allowing equity to work over a reasonably long timeframe.
How much should I invest in equity?
There cannot be a generalized asset allocation for one and all. A professional investment advisor such as a Registered Investment Advisor (RIA) will help you arrive at the right allocation. RIAs are registered with the Stock Exchange Board of India (SEBI) and play a fiduciary role. This means that they are focused on giving you the right interest for a fee. It is illegal for them to make any commission income.
Equity is an asset class that provides inflation-beating returns. One should not ignore or avoid equity investments considering equity is risky. As we’ve explained, there is a risk in fixed-income securities, too.
Conclusion:
Mutual Funds are actively managed Stocks. They provide great diversification than Stocks. However many mutual funds carry the risk of over diversification which greatly reduces returns over time.
If you have access to a competent and professional equity advisor who does not make side income on your money (eg: brokerages), then equity investing is a very good option.
Happy investing….!
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