Wealth Creation - Equity (Share) Route to invest (in equities) or not to invest

Since the last 5-6 months, we have been writing articles in your esteemed publication and we have been repeatedly talking of various modes/strategies of investment. This should be the appropriate time to dwell upon the issue of investing in equities and the risks and returns to be expected – in the medium to long term.

The equity markets both primary – IPO/Public Issue and Secondary – Stock Exchanges, have taken exceptional and unbearable beating for various logical and also frivolous reasons. Many investors who:

• entered at later part of the rally (19000/21000 sensex levels)

• played speculative game of leveraging in Futures/Options (Derivatives)

• invested/traded with borrowed funds

• Discipline, common sense and sense of responsibility to wind (led by sheer greed) have suffered very heavy losses.

However, the investors with medium to long term perspective and with discipline have managed to survive. The loss if any, in their case is just notional – on paper.

The moral of the present carnage is very simple:

• Remain within the limits of available long term funds – own funds & be Fundamental

• Have long term perspective (in long term, equity as an asset class is bound to outperform any other asset class, meaning thereby – there are hardly any chances that you may incur a loss)

• Avoid short term trading/speculation, be it in spot – cash segment or futures and options

• Do some basic spadework and just do not invest relying on any information without verifying the reliability and logical reasonability of the information. Plethora of information is available today. This should be distinguished from rumours (Tips) without proper base.

• If you want to be contrarian, all the more necessary to the spadework

• Never be fully invested in equities, always keep some liquidity for better opportunities

• Investing in equities needs long term view. Hence, never invest short term funds in equities

• It may be advisable to have long term perspective and concentrate on profession rather than spending the prime time before the terminal – trading in equities. In such ultra short term, the gain would normally be within five per cent and the risks involved in terms of potential losses (this happens at least two times every year, where often profits are more than washed out resulting in losses), diversion of focus from main occupation, loss of time for professional updating, etc. are not worth the name.

• Investing and earning reasonable and stable returns over a longer timeframe is more enjoyable. We always have enough tensions in our professional work and on social front. It is not worth taking more tensions again in trading on the Exchanges (stock or commodities)

• When greed overcomes you, be led by fear and when all others are fearful, be practical

• Wealth is sustainable but the returns may not be in the long term

• Keep your strategy very simple – complicated strategies often fail

It seems the list is becoming heavier than one can digest at a time. Let us look at some logics in our next article.

Even in this worse period in stock markets, there is a lesson to be learnt, may be an expensive one. The concept of stock market game is to invest and enjoy. How this can be achieved!

In case, you have done the spadework and carry the conviction, you will not be disturbed by any turmoil such as the present one. This is simply because you have the confidence in your decision and hence you can logically stand by the same. You may treat this situation as an opportunity to top up your investments at attractive valuations. The enjoyment of bargain hunting in discount sale is all yours.

The data tables show the effect of long term investing habits, how one can benefit from this and what can be the possible risks.

For comparison, we prefer to use the mutual fund performance analysis for various reasons (pardon us, it is not a marketing gimmick). In case of individual scrip, it may become unrealistic or inconsistent to compare its returns over a period, as the current (or some period in past) scenario may be too encouraging for that company or that sector or otherwise for different reasons. The mutual fund – a diversified equity scheme with large cap bias represents an investment in 8 to 12 different sectors and 30 to say 60 different scrips within those sectors. Hence, it becomes more averaged and consistent to compare and analyse the returns of such funds. It is a more meaningful exercise and can be continued over a period of time in future. This apart, the mutual funds offer a more convenient and flexible way of investing in equities, without compromising on the quality and yield.

We take the latest available data – as of Friday, 7th March, 2008 for this purpose.

The returns are average. We may safely take them to be in range of 15% that is +15% for some better performing funds and -15% for some funds below average.

(Note: The average performance data in the above table is based on various criteria of analysis consistently followed by the concerned agency. The sector classification is broadly as per the directives of regulatory authority.)

We may note here various amazing findings – though not relating to a particular fund.

• In short term – the returns are absolutely not predictable. (going back to the basic principle that equity investing is for long term).

• In medium term, to some extent predictability is there, but it would be an attempt to time the market, in which very rarely someone has succeeded.

• In long term – say five years and longer, very rarely one goes wrong (Rider, investment in fundamentally good company share)
  
  We can use the same route even for the tax saving investments under Sec. 80C of the Income-tax Act. Today, we look to PPF, NSC, LIC, etc. for these investments. It is high time, we give due weightage to the tax saving ELSS funds. The basic advantages

• Reduced lock in – only three years;

• Market related returns without any upper limit (also no lower limit);

• Periodic (not regular) profit booking – tax free (now) in form of dividends

• An effective shelter if EET is implemented by Govt. in future.