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Patience Pays - Investing in Equity


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This booklet seeks to explain the benefits of long-term investing and how it makes sense to stay invested

Published in: Economy & Finance, Business
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Patience Pays - Investing in Equity

  1. 1. Rs RsRs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs Rs RsRs Rs Rs Rs PATIENCE PAYS Presented by Equities deliver the best returns if held for the long term. Here’s how you can create wealth from this asset class The content for this booklet has been developed and designed exclusively for Franklin Templeton Investments by Money Today, a part of the India Today Group (Living Media India Ltd.).
  2. 2. 1Patience Pays 2 High Growth The power of compounding helps build a large corpus in the long term 3 Starting Early Investing early gives your money the opportunity to grow more 4 Best Performance Equities is the only asset class to offer protection against rising prices 5 Profit Over Time Equities overcome short-term volatility to give stable returns in the long run 6 Minimising Loss By investing for the long term, you can earn high returns at minimal risk 8 India on the Growth Path All indicators forecast a high rate of economic development in India 10 Patience Pays All the reasons why “Patience Pays” for investors 11 Advantage Mutual Funds Why mutual funds are the safest and easiest way to invest in equities Cover Illustration: PRAGATI Equities CONTENTS 4 No other asset class has given higher returns than equities in the long run 2 By investing small amounts regularly, you can optimise the power of compounding 8 India’s potential for high growth is good news for the stock markets
  3. 3. A nswer this simple question. In which case will you have more money at the end of a month— one paisa that doubles every day or - Rs 1 lakh a day? It seems like a no- brainer. Of course, Rs 1 lakh a day will build a larger corpus, right? Wrong. Actually, one paisa per day will grow to Rs 1.07 crore in one month, whereas Rs 1 lakh a day gen- erates a corpus of Rs 31 lakh (assuming 31 days in a month). Sounds incredi- ble, but it is the magic of the power of compounding. The concept of com- pounding is simple: when you first make an invest- ment, you earn interest on the principle. If you do not withdraw the money, the interest is reinvested and you earn interest on not just the principle but also the interest. Over time, the total returns from the prin- ciple and reinvested inter- est grow exponentially, resulting in a large corpus. According to the example in the graph, (see Magic of Compounding), if you start investing as little as Rs 1,000 a month, at the end of 30 years, your cor- pus will total about Rs 69 lakh, assuming that the instrument grows at an annu- alised rate of 15%. This is why experts sug- gest that you invest a small amount regularly as it gives a huge payback in the long term if you do not with- draw the money. The more time you give your money, the more it can grow. For example, Rs 1,000 invested every month at 15% p.a. can grow to Rs 69 lakh over 30 years. All rate of returns are annualised. Magic of Compounding 70 50 30 10 -10 Rsinlakh Months 15 % 10% 6% Rs 69.23 lakh Rs 22.60 lakh Rs 10.04 lakh 50 100 150 200 250 300 350 High GrowthThe key to financial success is investing for the long term. This allows you to optimise the benefits of the power of compounding
  4. 4. 3Patience Pays T o optimise the benefits of compounding, you must keep your money invested for a long period of time. The two variables are directly proportional: the longer the time period, the higher the returns. As you grow older, the number of years for which you remain invested reduces. Consequently, if you start investing early, you have more time to exploit the power of compounding. Consider the graph, Early Bird Advantage. Both Preeti and Rohit invest the same amount, Rs 10,000, every year. However, Preeti starts investing at the age of 25, 10 years before Rohit. By the time they retire at the age of 60, Preeti’s corpus (Rs 33.41 lakh) is more than double that of Rohit’s (Rs 15.03 lakh) though both investments were earning the same rate of return. This is because, by starting at the age of 25, Preeti invested for 35 years, whereas Rohit invested for 25 years only. The power of com- pounding yielded better returns for Preeti as she remained invested for a longer time. A practical reason for starting early is that between the ages of 25-35 years, most people need not dip into their invest- ments for big-ticket expenses, such as chil- dren’s education or mar- riage. If you withdraw money from your invest- ments, the effect of the power of compounding gets diluted. As a result, you will be unable to build a very large corpus. Starting Early Preeti invests for only 10 years compared with Rohit’s 25 years. However, as she started earlier, her money grows to Rs 33 lakh as opposed to Rohit’s Rs 15 lakh. 40 30 20 10 0 Rsinlakh 40 30 20 10 0 Rsinlakh Preeti Rohit Rs 33.41 lakh Rs 15.03 lakh 25 30 35 40 45 50 55 60 Early Bird Advantage The assumed rate of return is 12% per annum Illustrations: PRAGATI Investing early gives your money more time to grow. There is also lesser chance of dipping into the investments that dilutes the effect of compounding
  5. 5. 4 Patience Pays Y es, the stock market registers bouts of zero growth or even negative returns, but in the long run, no asset class comes close to generating returns as high as equi- ties. In the past 15 years, the price of gold has risen by 7.2%, whereas oil gave 10.29% returns. But the king of returns was equities, with the Sensex growing by 11.39% in the same time period. Equities is the best hedge against inflation which singed wallets as it rose from 4.95% in January 2009 to 8.56% in January 2010. This is why if you’re investing for long-term goals such as retirement or your children’s education and marriage, you cannot afford to ignore the corrosive effect of rising prices on the value of your assets. The only effective weapon against inflation is equities. Consider this: for the period between January 2000 and January 2010, the compound annual growth rate (CAGR) for the Sensex was 12.31%, which was 6.84% more than the aver- age Wholesale Price Index (WPI) of 5.47%. It seems that the era of high prices is here to stay. Therefore, you must create a portfolio of instruments that will provide sufficient returns after factoring in the rate of infla- tion. Equities is the only asset class that does so consistently. You can opt to invest in equities via stocks or mutual funds. Equities King of Returns 1 year 5 years 10 years 15 years 96.02 20.50 12.57 11.39 19.51 20.28 14.41 7.20 74.26 7.74 10.49 10.29 Sensex Gold Oil Data as on 15 March, 2010; Returns are CAGR (%). Source: BSE Equities has consistently outperformed all other asset classes. Therefore, it works well against rising prices Best Performance
  6. 6. 5Patience Pays V olatility is inherent to the stock markets as share prices change starkly in a very short span of time. Most investors find this scary and, in order to sleep peaceful- ly, they eschew equity investment altogether. However, this is not necessary. Though short-term market swings can give you negative returns, in the long run such phases of zero growth are averaged out. Over decades, equi- ties generate higher returns than less volatile instruments and are less risky than the apparently safe instruments. This is what investors do not realise and chase quick returns from the market while looking for long-term safety in debt. Short-term share price fluctua- tions are influenced by fads and news. In the long term, only the good busi- nesses survive. So the investors who let their fears overwhelm their good senses are the ones who lose out when the markets are volatile. Consider the graph showing investor emotions in the short term. As the market swings down, investors move from anxiety to fear and, finally, panic when the market hits the bot- tom. This is when most investors exit the markets and ignore the opportu- nity to invest more at low valuations. Subsequently, the markets rise again and this process evens out the nega- tive returns in the long run. Profit Over Time Relief Excitement Exuberance Anxiety Fear Panic Hope Relief Mood shifts in the Short Term When markets hit a low, they offer a buying opportunity but investors are too panicky to exploit it. The stock market overcomes volatility in the short term to give high returns over time. Data as on 15 March, 2010; Source: BSE, Data as of March 15, 2010 One Way up in the Long Term 24,000 20,000 16,000 12,000 8,000 4,000 0 Rsinlakh CAGR since launch 15.27% 1986 1998 2010 Though the stock market is volatile in the short term, it has the potential to create immense and stable wealth in the long run
  7. 7. 6 Patience Pays I t is every investor’s dream to get high, yet, secure returns. This proverbial pot of gold at the end of the rainbow can be real if you stay invested in equities long enough. If you consider the rolling Sensex returns over different time periods, (1, 3, 5, 7, 10 and 15 years), the results reveal that as the investment horizon increases, the probability of loss drops. You never lose money in the long run, yet stand to get decent returns. Since its launch, the Sensex has grown at a CAGR of 15.27%. Equities has been the best per- forming asset class in India over the past 5, 10 and 15 years and it is like- ly to be the best performing asset in the coming decade too. According to a Morgan Stanley research, the Sensex is expected to deliver annual returns of 14% over the next 10 years. Also, Indian equi- ty returns are likely to be less volatile in the coming decade than they were in the previous 10 years. As far as volatility is con- cerned, the research points out that return volatility in the coming years is also likely to be reminiscent of the post-1987 9 Minimising Loss Market volatility affects returns the most when the holding period is the shortest (one year in this case). Over a 10-year period, all the possible short-term losses are more than recouped. One-year Rolling Return 1996 2010 120 80 40 0 -40 -80 CAGR(%) Ten-year Rolling Returns 2002 2010 25 20 15 10 5 0 -5 CAGR(%) Though investing in the stock market is a risky proposition, it is possible to minimise the probability of loss by staying invested for the long term
  8. 8. 7Patience Pays period, when the volatility in equity returns moderated after hitting a peak. The fundamentals of the Indian corporate sector are in a good shape backed by the strong domestic growth (on the back of robust domes- tic demand), robust balance sheets, high capital efficiency and the likeli- hood of decoupling from the rest of the world. This will be a source of strength to the market in the medium to long run. Thus, on a risk-adjusted basis, equities are likely to be the most attractive asset class in the future. 3 6 12 20-year Rolling Returns 2006 2010 22 20 18 16 14 12 10 CAGR(%) The base of 0% return is not even a factor for a holding period of up to 20 years. Chances of Loss over Time 1 year 3 years 5 years 10 years 15 years 20 years 36.29 19.82 13.40 2.16 0 0 21.43 18.51 17.73 12.81 12.83 17.07 Probability of loss Holding period Avg return CAGR (%) Only buy something that you would be perfectly happy to hold if the stock market shuts down for ten years. – WARREN BUFFETT As the holding period increases, the possibility of incurring a loss becomes virtually nil. Data as on 15 March, 2010; Source: BSE
  9. 9. 4 Patience Pays8 N ot only did India weather the recent crisis, it actually grew at a pace second only to China, demonstrating that it has built the foundation for a strong growth. This is good news for all investors. A high-growth trajectory will directly influence the stock market, which will mirror the same path. Here is evidence to prove that the good times may be here for a long time: Economic Factors The global economy is reviving, which means that trade and credit offtake will improve. Back home, the empha- sis on fiscal consolidation should ensure that the government meets its target growth rates and the public debt is under control. The accom- modative monetary policy environ- ment created by policymakers shows a flexibility that is necessary at a time when we are recovering from a slowdown. The fact that the Indian banking system was not crippled by the global malaise stands testi- mony to its strength in terms of capitali- sation. A strong banking net- work is cru- cial for industrialStrong GDP Growth 12 6 0 Percentage 1990-91 2011-12E Illustration: RAJ All macro indicators reveal that India has the potential of becoming an economic superpower in the next decade, which will reflect in the stock market India on a High Growth Path
  10. 10. 9Patience Pays growth and Indian banks are prepared to back both the industry and com- mon people. Similarly, the govern- ment’s thrust on infra- structural growth should boost productivity, whereas programmes for rural areas will ensure inclusive growth. This is possible due to a stable political environment, which goes hand in hand with economic stability. Social Factors India is famous for its domestic sav- ings. The consistently high savings rate implies greater economic securi- ty for its people. So far, the Indian growth story has not been as inclu- sive as it ought to have been. A large section of the rural population does not have access to infrastructural amenities like banks, educational institutions, etc. This means, there is enormous potential for growth in infrastructure, consumer goods, etc. Though there is much work to be done, recent social welfare pro- grammes like the National Rural Employment Guarantee Act, pay revision, higher minimum support prices, etc, have ensured an increase in the purchasing capacity of rural India. However, one of the most favourable social factor is the demo- graphic profile of India. The working age population is expected to shoot up by 240 million in 20 years. This will result in a dramatic growth in pro- ductivity and savings. So the long- term positive outlook for India is based on strong fundamentals. Net Domestic Savings 1400 0 Rs’000crore 1989-90 2007-8 A high domestic savings rate will result in greater economic security for people in the future. Outlay on Rural Employment 450 0 Rs’000crore 2004-5 2010-11 As rural employment increases, the purchasing power of villagers will go up, generating demand. Source: CSO, Budget Estimates
  11. 11. 10 Patience Pays B y now, it must be clear that investing in equities is indis- pensable for a healthy growth of your portfolio. However, do not be greedy and seek returns in the short term. Most investors lose money by taking on more risk than they should and churning their equity portfolios too often. Instead, stay invested for the long term and use the money only when the financial goal is near. Here are some of the things you must remember about equities: Invest for the long term: The best returns come to those who wait. Equities generate the highest returns in the long term and face minimal chances of loss. So if you have bought good companies, stick with them. Review your portfolio: This does not mean you must make unnec- essary changes. By doing so, you do not allow your investments to multiply in value through the power of com- pounding. Too much churning also increases the cost of investment. You may have to pay short-term capital gains tax of 15% if you book profits within a year. Do not try to time the market: Stock markets are inherently volatile. Therefore, you cannot predict the movement of stock prices. Do not be influenced by fads or trends. Stick to good businesses and you will reap rich dividends in the long term. Believe in India’s economic growth: All factors seem to favour the predic- tion of high growth. Domestic savings have been over 30% for the past six years. The workforce is expanding, which should lead to high- er savings and produc- tivity. Over 70% of the population is rural; focusing on their needs will boost income and generate demand for the economy. Patience PaysInvesting in equities is a must to ensure high growth for your portfolio. To minimise the chances of loss and maximise gains, stay invested for the long term
  12. 12. 11Patience Pays RETURNS H ow can you be sure that a stock will come good in the next 10 years? You can’t, because you don’t have the required insight into the markets. So why not leave the task to the people who are trained to invest in equities? This is exactly what mutual funds do. A spe- cialised fund manager invests your money in a cache of stocks, which are chosen according to the fund’s mandate. The manager tweaks the investments regular- ly to ensure that you get maxi- mum returns. Here are some of the reasons mutual funds are a must-have in your portfolio: Big and safe returns Mutual funds offer the best of both worlds: high returns and safety. Though the returns may not equal to those from the best stocks, you rarely lose money by investing in funds for the long run. This is prima- rily because funds spread invest- ments across stocks and sectors, which maximises the benefits of diversification. Therefore, you forgo less in terms of returns and gain more in terms of security. Best minds at work As mentioned earli- er, mutual funds are run by fund managers who make moves based on in-depth research and analysis. These investment professionals don’t follow the sound bytes on TV but make forecasts with the help of teams of experts that regularly study the market. As an ordinary investor, you do not have the time or the expertise to analyse the markets like these managers. Funds offer you the opportunity to tap into The most convenient and safe way to invest in equities without compromising on high returns is through mutual funds Advantage Mutual Funds
  13. 13. TAXTA Rs Rs fINANCIAL PLANNING + - = . 1 2 3 4 5 6 % 9 /* OFF CE ON8 7 M + 678242 the resources of trained professionals to make money for you. Financial planning There is a fund for every need, strategy and time period. This is why they are perfect instru- ments for finan- cial plan- ning. If you are a conservative investor, choose large-cap equity diversified or index funds. If you are aggressive, pick from mid-cap, small- cap or sector funds. In case you want high returns without too much risk, opt for balanced funds, which invest in a mix of debt and equity. You can also bet on sectors by puting your money in funds that invest in stocks belonging to a particular industry, such as infrastructure funds, banking funds, etc. Another option is to retro- fit a fund to your financial goal. For instance, to build a retire- ment corpus, choose from equity diversified funds, which is one of the safest category of funds. Starting small Systematic Investment Plans (SIPs) allow you to invest small amounts in mutual funds regularly. The lower limit is as less as Rs 50 a month. Not only does this discipline your invest- ments, it also averages out returns in a volatile market. A lump- sum investment before a bear day can wipe out all your invest- ments. With SIPs, the hit impacts smaller amounts. Similarly, you never miss a bull run because you did not see it coming or because you were out of money. SIPs automatically ensure that you participate in every market movement. Tax saving Equity-linked s a v i n g s s c h e m e s (ELSS) is one of the two market-linked, tax-saving instru- ments under Section 80C of the Income Tax Act (the other being Ulips). By committing to SIPs in ELSS, you can spread out your tax savings through- out the year without sweating to meet the deadline in March. This also gives you the benefit of rupee-averaging much like the SIPs in other mutual funds. 12 Patience Pays