Who should invest in Equity?

Investors all over the world have suffered huge losses through equity investments in the year 2008. Both BSE Sensex and CNX Nifty have given a negative return of around 53% during the year, which is their worst yearly performance ever. The performance of mid cap and small cap indices has been worse. Investors who have seen their portfolios bleed have put a question mark on equity investment as a wealth creation tool. Even advisers and financial planners are finding it hard to convincingly recommend equity investments to their clients. This leads us to the important question: Whether one should invest in equity at all, and if yes who should invest in equity instruments?

Let us try to find answers to this question. Surplus cash available with an individual can be put to use in three different ways:

1. Liquid assets: Cash in hand, Liquid bank deposits (Savings & Current accounts). This represents idle cash which is used to cover routine expenses and emergency requirements like sudden illness/ accident etc. About 4-6 times monthly expenses are sufficient to cover these exigencies.
2. Debt instruments: These are fixed income securities (both secured & unsecured) which are designed to give stable returns over the short term, the risk increases if debt instruments are held for long term because their return is dependent upon inflation and market interest rates.
3. Equity instruments: Equity represents the holders proportionate ownership in the invested company. One must understand that as owners of the company you have a share in the profits as well as losses generated by your company. From this angle equity investment or ownership must be taken with a long term perspective. Your horizon for equity investment should not be less than 3-5 years.

Thus, equity investment is generally rewarding in the long term and debt investment is generally rewarding for the short term. One must choose the investment option based on your goals: Short term goals maturing within 1-2 years need to be financed through debt investments and long term goals with a horizon of 5 or more years need to be financed through equity investments. Another way to look at equity investment is the 'Risk appetite' of the individual. Risk and return are directly proportional to one another, thus, you can hope for a higher return by taking a higher risk. Equity investments carry a higher risk as compared to debt instruments because they have the potential to give higher returns. Please do not enter equity markets if you are risk averse. However, the risks to equity investment can be diversified in two ways:

• Product/portfolio diversification: By distributing the investment amongst large number of stocks/ sectors.
• Time diversification: Buying small lots of your favourite stock through SIP (systematic investment plan), rather than in one go. Investment through Mutual Funds meets both these diversification methods.

If you had followed the above two principles, you would definitely have reduced your notional loss during 2008 (there is no loss unless you have booked it through sale of stocks at a loss). There is every likelihood of investors making profits if they remain invested for long term. Of course, one must have reasonable expectations from equity investment (The long term average is around 17-18% per annum), and one should be ready to book profits whenever these expectations are exceeded. After all it is your money and you need not blame any one else for having or loosing it.