A reader wants to know a way to convince his friend to start investing in equity —a discussion.
To not invest in equity is a choice. Whether that is an informed choice or not is another matter. Friend or relative, I don’t think we should try and convince anyone too set in their ways to change it to something we feel is correct. Who knows, someone not investing in equity might end up wealthier or manage to find enough money for their long-term goals.
When I started investing in 2007/8, I knew no one around me with any capital market experience. This is how I convinced myself to invest. It may not appeal to everyone. If it makes someone like your friend think (assuming he/she takes your suggestion to read this seriously), it will make me fleetingly happy. Beyond that, to each their own.
Let us go back in time to the year 1990. A cup of tea at a roadside shop would have cost about Rs. 0.5. Fast forward 33 years, and in 2023, we will have to shell out Rs. 12-15 for the same cuppa.
The annualized inflation rate over 33 years is about 11%. Now suppose you had Rs. 1 with you in 1990. You use half of that to buy a cup of tea and invest the other half.
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After 33 years, you withdraw the money, pay the necessary tax and use the rest to buy a cup of tea. Unless you have Rs. 12-15 with you cannot. And if you cannot, inflation has degraded your purchasing capacity.
Naturally, if you had other sources of income, you would not bother much as you can source funds from elsewhere, but what happens after retirement? That is when the impact of inflation is most painfully felt.
Now suppose you have Rs. 30 in 2023. You spend half of it to drink a cup of tea and invest the rest. If you wish to drink a cuppa after 20 years, your investment should have grown to Rs. 121 (assuming the same 11% annualized increase) after tax.
This means a post-tax return of 11%. Suppose you want to invest in something safe, like an FD that offers 6% after tax. Then unless you invest Rs. 38 (more than double the current cost of roadside tea), you cannot buy the same after 20 years.
The true cost of seeking safe returns is the higher investment necessary to offset inflation. Very few can afford to invest the extra money. Therefore, investing in market-linked instruments is the only way to increase portfolio return and combat inflation.
Historically, although there are no guaranteed returns, equity has more often than not beat inflation: Why should I invest in equity mutual funds when there is no guarantee of returns? Also, see: Equity may beat inflation, but that doesn’t mean you will!
Thankfully not all our expenses increase at 11%. The average inflation of all our expenses has come down over time. Currently, an inflation estimate of 7% is reasonable.
This does not mean the overall return needed to keep pace with inflation is just 7%. First, fixed-income instrument returns go down with time as our economy develops (along with inflation). Second, there are taxes to consider. This would mean the net return with fixed income will almost always be lower than inflation. So using fixed income alone is quite risky as it would guarantee that our purchasing power is lower than necessary.
We need a good amount of equity in our portfolios, and the best time to include this is when young. When our goals are decades away, the risk associated with equity investing becomes reasonable and eminently manageable. We recommend an initial asset allocation of 50% equity and 50% fixed income.
This is a video on the topic from our YouTube channel.
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