03 Oct Check if You are Ready for Equity Before You Invest
As the Sensex plays touch and go with the 29,000 mark, many new investors are coming into the equity market. However, to create value for their investment, they will have to weather the next downturn too…
Nearly 3.8 million new folios were opened for equity-oriented mutual funds between June 2015 and June 2016, an increase of about 12%. This came on the back of around 10% increase in folios in the year before that. A steady rise in equity folios among retail investors is an encouraging trend because steady investment in equity will help you create long-term wealth.If you are intrigued by equity, or want to come back to it after having suffered a bad experience—the first step is to ensure that you really are ready for it. To be ready for equity, you must understand the difference between growing wealth and earning regular income, be able to withstand volatility and remain invested for many years.
Growing wealth is not the same as regular income
Income is what a fixed deposit (FD) gives you, on a specific date. You know what you will get. You can even choose when you receive the payout, by choosing the tenure of the FD. This is regular income. What it doesn’t do is grow your money.
But equity brings you growth. Amol Joshi, founder, PlanRupee Investment Services, says, “Equity is about buying into the fortunes of a company. Salaried individuals expect an increments every year. How does that happen? The company makes a higher profit and pays you more. Buying equity is another way to benefit from a company’s profit growth. You become a shareholder.”
You partake in profit growth, which leads to wealth creation through positive change in stock price. Picking good-quality stocks and funds, or getting an adviser who helps you is important.
According to Kavitha Menon, a Mumbai-based financial planner, “Clients usually want preservation of capital. They don’t understand that value can move up and down. I encourage them to…invest a little and remain invested to see the benefits”.
There is another aspect to growth: inflation. It reduces the purchasing power of money. Historical data shows that, after paying taxes, regular interest-bearing investments are unable to beat inflation in the long run.
According to Deepali Sen, founder and director, Srujan Financial Advisers LLP, “Some clients resist equity in the beginning, but once they understand that this is the most suitable asset to beat inflation and grow money in the long term, they come around. It also has to be explained that there is logic behind it and it’s not chance”.
Stay invested through short-term volatility periods
“In the long run, what matters is what you own. In the short term, it’s about demand and supply of a stock, which can be influenced by many factors, some of which are external,” says Sen.
A good-quality stock represents earnings of a good-quality company. However, if on a given day there are fewer buyers for that stock and say, foreign investors are selling (they could be exiting emerging-market equities), you may see a drop in stock price. This could continue for a few days.
However, if the company’s earnings continue to grow steadily at the assumed pace, stock price will also move upward.
“Good companies continue to remain good for a long time and bounce back from setbacks,” said Joshi, citing the example of Nestle India Ltd after Maggi was banned and how it is back again as the top-selling instant noodle brand.
Menon says, “No one looks at property prices daily and even when they fall, people are willing to hold for 15-20 years. A daily price makes you want to act often. It’s important to constantly communicate and advise clients through market downturns, so that one knows what’s happening rather than taking quick action.”
Daily news and events can impact the market price of shares. In the first 2-3 years, you should be ready to incur notional capital losses. Wait it out as the fundamentals eventually catch-up.
Varun Girilal, co-founder and executive director, Mitraz Investment Advisors, says, “We tell clients at the start itself not to compare returns for at least 3 years. We can discuss portfolio construction and the process, but returns are built only over time, not just 3-6 months.” Both Menon and Girilal reiterated that corrections are a time to invest more and it’s the adviser’s role to communicate this effectively.
Longer is better
Girilal says, “While showcasing equity to clients, we often take historical data. Let’s say 15-20 years ago, one wouldn’t imagine that the Sensex could be at 30,000 but it’s almost there. Years later it will be at a lakh, but today that seems unimaginable even though there is enough logic to support this.”
In an earlier story (http://bit.ly/1VnytXm ), Mint Money had used historical data to show that the longer you remain invested in equity, the less it matters when you actually started your investment process. What really matters is that you remain invested. The average return earned for staying invested for 10 years doesn’t change by much, even if you remove the top 20% returns, the average doesnt change much.
What this means is that with time comes not only growth in wealth but also stability in returns.
Sen says, “When you approach equity as a solution for long-term goals, it’s easier to understand why one has to remain invested for 5 or 10 years or longer. Those who aren’t really planning a goal, may never understand what it means to be in equity for long term.”
Financial advisers help investors to overcome the fear of volatility and risk of capital loss in equity investing, by engaging in constant and effective communication. Many have to handhold clients through market downturns, to ensure that an exit doesn’t take place due to panic.
Start small, remain invested and you will find that equity can effectively beat inflation and be your solution for long-term wealth creation.
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