The two asset classes Debt and Equity have completely different characteristics and it never ceases to surprise me that investors get terribly mixed up in buying decisions for them. Of course, a lot of this is due to the wrong concepts which have been promulgated by financial planners and self-proclaimed experts in the financial space.
So people will tell you things like – (a) Equity is for the long term so you should start investing in it as quickly as you can. (b) If you invest in equity early you will get a greater compounding effect. (c) Over the long term you can get returns of 15 % to 18 % through equity.
It may surprise you to know that all the above statements are essentially wrong or based on inadequate data and flimsy premises. (a) is something that will be generally borne out but you do not buy equity based on time, and this is where it falters badly. You must buy equity based on market levels or the price of stock / MF. For example if you bought Jet Airways at a price of 1000 Rs in 2008 January, you would still be having a loss in it, despite the stock having done rather well of late. Time MAY have a direct correlation to returns but it is by no means well established.
(b) is wrong because equity returns simply do not compound. I have had this debate with several people who are regarded highly in the financial blogging universe and they have finally been forced to concede the point. This whole idea started as MF companies wanted people to keep investing money, playing on the compounding theory from the debt universe which was familiar to all. Once they managed to brainwash enough number of people, the Domino effect took over and ensured that every other person that you meet, is a financial expert singing praises of SIP. I actually meet people who think SIP is a product that their financial planner has searched for them with great difficulty !! If you are interested in knowing why equity returns do not compound, read some of the relevant posts in my blog.
(c) is wrong simply because there is not enough data in our markets to show the validity of the statement. There are markets in developed countries where 15 years have produced very little returns, there is nothing to say the same cannot happen in India. My problem is not with investing in equity, I do it a lot and think it is the best asset class we have at present. However, to mislead gullible investors into thinking that equity over 15 years is almost like a tax free fixed deposit, is not only wrong but almost criminal in it’s intent. You may go through 15 years and find that you have earned less than your PPF account.
While pushing this for equity many experts try to advise people how they should buy Debt funds with interest rate cycle fluctuations in mind. Again, pretty good in theory but it can horribly go wrong, as we saw in 2013 when a reversal of interest rate cycles wiped out all gains from Gilt funds and the likes.
So what should you do? Never try to go against nature – buy Debt early so that you really get the benefit of compounding. Fortunately PF and PPF ensure that for most of us this continues to be true. If you do not have a PPF account there are enough good reasons to open one today. Read some of my posts in the blog to understand it better.
As far as equities go, there is no need to depend on time. You do not have to invest every month or even every quarter. Invest only when you feel you are buying at the right levels. Yes, you do need to understand DMA and stuff, but believe me that is much better than blindly doing SIP. I have myself done SIP for 7 years and could kick myself for it today.
You need both Equity and Debt in your portfolio but take care that you are using the right methods to buy them. That will have a huge bearing as to how much your portfolio grows over your investment life.