Saturday, May 14, 2011

Equities may offer the best way to create wealth

Robert F Kennedy famously said: "Only those who dare to fail greatly can ever achieve greatly." Creating wealth surely requires risk appetite. Wealth, in fact, is the accumulation of possibilities.


Investors have different options to invest their money and every option comes with its own related risks and rewards. Investing in equity has a higher risk and higher return proposition, whereas investing in debt comes with assured returns, but the gains are modest. In a globally integrated economy, the return on investments depends on the risk appetite. Any fixed or guaranteed return instrument provides very low return, which may not even cover inflation. Thus, the deployment of savings in such instruments will surely fail to meet the objective of wealth creation. On the other hand, investments in the real economy, ie, in performing businesses directly or in them through the share markets can surely beat inflation and generate significant wealth.


In today's Indian economy, which is growing at a pace of 8-9 % per annum and where inflation is hovering around 7-8 %, the average nominal return from investments in shares should be around 15% (ie, average GDP growth + average inflation). Calibrated selection of stock portfolios can obviously enhance this return significantly and create great wealth. The billionaires of today are shareholders of well-performing corporations, whether as owners/promoters or individual investors. It is also apparent from the performance track record of equity markets that over time, equity investments beat all other investments in terms of returns.


The apprehensive about investing in equities because of the risk involved is understandable, but that blocks a good avenue to creating wealth; one should manage the risk and reduce it to the least possible acceptable level. Equity markets are no longer the exclusive realm of the skilled risk-takers . With increasing income levels, handsome returns and booming index, only a few dare to shy away from the markets. Even investors with low-risk appetite hold a share of the equity markets through balanced or equity mutual fund holdings. In order to beat inflation , some financial advisors recommend that even retired individuals should lock a portion of their investments in equity. Risk and uncertainty are the key factors that propel the returns from investment in the stock market to much higher levels than from savings accounts , CDs and bonds . The key is using the risk and uncertainty of a stock market to one's advantage.


A well-planned investment strategy begins with a proper asset allocation plan. This is the first step to wealth creation. Asset allocation refers to spreading investments among different asset classes. The different asset classes perform differently and react differently to market conditions, thus significantly reducing your portfolio's volatility . Holding a diverse range of assets is important because it spreads your risk by reducing your dependence on the performance of one particular asset class - a positive performance in one area will offset periods of weakness in other investments. As well as diversifying across asset classes, you can diversify within each asset class spreading your risk even further . Within Australian shares, for example, instead of just focusing on banking stocks, you could also invest in resources stocks or infrastructure assets. Besides big 'bluechip' stocks, you could look at 'small-cap' investments in smaller businesses with lower market capitalisations. The rapid development of the Indian economy over the last few years and the expected continuation of this growth momentum over the next 5-10 years present a unique opportunity, which may not exist once the economy matures and the rate of growth slows down. Our generation is, in fact, blessed with this unique wealth creation possibility through sensible stock market investing.

Sudip Bandhyopadhyay, President, Destimoney Securities 
Source : ET

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