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Qeuity investing offers better inflation adjusted returns

As an investor, you have the freedom to select from a basket of products where you want to put your money. These include less risky assets like fixed deposits, bonds and provident funds to risky assets like equity and currency, to relatively illiquid assets like real estate to popular investment options like gold and silver. There are other not-so-talked about investment products like art works, wine, stamps and coins.

Of all the financial products available to you, equity offers several advantages over other asset classes. According to financial advisors and planners, one of the main advantages for equities is the inflation adjusted return one could expect by investing in them. For example, if the annual rate of inflation is 10% and your bank FD is also paying interest at 10% per annum, although you can see your money grow year after year, but all that growth is eaten away by inflation. That is because what you could buy for Rs 100 a year ago costs Rs 110 now, the same amount that you now have in your FD.

So your purchasing power remains constant. In case the rate of interest on your FD is lower than the rate of inflation, every passing year you are worse off in terms of purchasing power. You would be better off only if you get FD rates that beat the rate of inflation.

Universally, equity is acknowledged as an asset class that delivers superior returns over other asset classes such as debt and gold in the long term. This is because of a higher riskreward ratio (skewed in favour of equity). Just take the case of you being a salaried employee in a company vis-à-vis you running your own business. As a salary earner, while you may get steady returns and periodic hikes, your upside is essentially capped even when your company does exceedingly well. On the other hand, as an owner of a firm, you get to enjoy the full benefit of the profits arising from your company. Yes, you may share your profits with other partners; nevertheless there remains unlimited scope for you to gain more.

In effect, by owning equity as an investor, you get the chance to be the partowner of a company whose shares you own. But you should be careful that while during good times the opportunity to gain is substantial, on the flip side, during bad times, like at the time of a slowdown or a downturn in the business of the company, you may also have to incur losses or realize much lower gains compared to other asset classes.

The same is not true of an asset class like debt, where you may enjoy fixed returns but not gain because the bank/finance company is doing well or lending more to customers. Similarly, if you buy a property, the bulk of the profit is made by the developer; or at best a private equity investor; what you enjoy later is perhaps residual capital appreciation.

Equities also insulate you from another drawback that FDs and bonds have, which is the reinvestment risk. For example, you have invested in an FD at 10% for three years. When it matures, the rate of interest in the economy has fallen and the same bank offers you a three-year FD at 8% rate of interest. So suddenly, you would see that your earning of Rs 10,000 per annum (assuming the FD amount is Rs 1 lakh), will fall to Rs 9,000. This is the reinvestment risk that you have to take while investing in FDs and bonds. Equity does not suffer from such a risk.

There are some additional advantages of investing in equity as well, which include no tax of gains on these investments if you invest for over a year and if you receive any dividend it's completely tax free in your hands. Not all types of FDs and bonds give you such blanket tax advantage.

It's true that investing in equities comes with some amount of risks. So if you are not trained in investing methods, you may take the mutual fund route or avail of the services of financial advisors and planners.

Happy Investing!!

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Some of the best Tax Saving Mutual Funds available ( ELSS Mutual Funds )

1. ICICI Prudential Tax Plan Invest Online
2. HDFC TaxSaver Invest Online
3. DSP BlackRock Tax Saver Fund Invest Online
4. Reliance Tax Saver (ELSS) Fund Invest Online
5. Birla Sun Life Tax Relief '96 Invest Online
6. IDFC Tax Advantage (ELSS) Fund Invest Online
7. SBI Magnum Tax Gain Scheme 1993 Invest Online
8. Sundaram Tax Saver Invest Online
9. Edelweiss ELSS Invest Online