Investing in Equity

The ultimate goal of making an investment is maximization of wealth. To
achieve this, it is important that the investor gets a rate of return on his
investment that exceeds the rate of inflation. Otherwise, the real value of the
investment has actually declined. Fixed income investment paths like bonds and
income funds offer returns that are no doubt certain and consistent, but their
returns barely match the rate of wholesale price inflation, and often fall
behind the rate of consumer inflation.

How then can we make our capital exceed inflation? The world over, there is
only one time-tested method-equity. These, as an asset class, have constantly
helped investors grow their capital much faster than inflation over time, even
after factoring in periods of sharp falls.

Equity essentially is owners' capital of company and has a right to profits
of the company. A company's profits are impacted by a number of variables
right from the global economy to the skills of its management and staff.
Consequently, profits vary from time to time and these variances in profits
impact the price of the stock for the listed company. Apart from the variances
in profits, the stock markets also collectively take an overall view of the
company's future profits and put a price to it. Thus, apart from its own
profits and prospects, the share price of a company is also impacted by the mood
swings of the stock markets and its investors. It is, therefore, no surprise
that the share price of a company varies, violently at times, giving anxious
moments to all investors. At the same time, despite these swings, in the long
term, various studies have shown that share prices reflect the intrinsic value
of a company.

Given
these swings in share prices, a retail investor must plan a systematic long term
and disciplined investment, for the simple reason that retail investors are not
equipped to figure out the highs and lows and entry-exit levels. Timing the
market often lands them at the rough end. They should realize that equity
investments are not meant to generate high short-term gains. The aim of equity
investments is to generate reasonably high long-term benefits.

Even the experts in the market, many a times, find it difficult to accurately
predict the peaks and troughs. It is believed that systematic investments
planning, is one of the best routes for investors and they will see the benefits
over a long period of time.

Equity investment should be done with a time horizon of at least three years.
It has been noticed, over the years, that the business cycles have shortened to
around three years and, for retail investors, it has been suggested that instead
of investing savings for retirement in fixed income products and trying to
generate income from equity, they should do it the other way round. They should
try and invest in equities for retirement and try to generate income from fixed
income in the short term.

Every investment has an attached risk. Whenever more than one outcome is
possible from an investment, there is always some amount of risk. Only the level
of risk is different. Using risk to analyze expected returns while investing is
measured to evaluate the kind of returns you should expect from the investment.
The return expectations should be based on the level of risk you can bear. In
principle, the higher the risk, the higher the returns.

Returns across various asset classes show that investment in equity shares
give the highest level of returns in the long-term, followed by corporate bonds
and deposits and, lastly, bank deposits and government debt. The level of risk
is also in the same order.

How much to invest in equity is based on personal financial status, age and
ability to take risk. Older individuals or those having a lower risk handling
capability should typically invest less in equity and more in debt. In general
situations, the model portfolio should contain at least 40-50% equity.

Having decided how much to invest in equity, investors have a choice of
directly investing into individual company shares or subscribing to different
schemes of mutual funds that provide a diversified portfolio of stocks.

Should the investors want to invest in direct equity rather than mutual
funds, they need to register with a broker with the two main stock exchanges in
India-the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE)-where
shares are bought and sold. A potential investor can invest through a broker or
directly buy a fresh issue of shares, which is called an initial public offering
(IPO).

Managements of most of companies in this sector are first generation
professionals and largely transparent in their operations. While, like all other
industrial sectors, the IT sector also has its ups and downs, in the long term
its prospects remain bright and, consequently, the sector offers a profitable
investment opportunity to retail investors and, especially, IT professionals who
have a fair idea about the dynamics of the sector. Caution, however, needs to be
exercised to limit the proportion of ones investment in the sector to 10-20%, to
avoid over exposure. Also, one should try to keep ones exposure in smaller
companies limited since these companies have potentially more risk than their
larger cousins.