ATM :: Equity investment’s the magic formula for financial planning


Varun Goel | Tuesday, 22 September 2015 – 6:35am IST | Agency: dna | From the print edition

ATM

The BSE Sensex delivered return of 100x over approximately thirty years. The index value, which was 260 in December 1984 has now become more than 28000. So if you had invested one lakh in 1984, it would have become one crore in 30 years. The average CAGR return in last thirty years is a stupendous 17%.

It’s time to get over your financial planning worries. The easiest and most convenient wealth creation tool has been ignored by majority of Indians for far too long.

The BSE Sensex delivered return of 100x over approximately thirty years. The index value, which was 260 in December 1984 has now become more than 28000. So if you had invested one lakh in 1984, it would have become one crore in 30 years. The average CAGR return in last thirty years is a stupendous 17%.

No other asset class has given those kinds of returns over the same period. Long term taxation on equity is zero, which means returns are tax-free. Also, the money invested in equity is always liquid and can be redeemed within two days in case of any requirement. So, we have an asset class which is liquid and delivers tax-free high returns (over 1 year). And the best thing is that you don’t have to take stock market advice or go to various stock ‘experts’ as you can just invest in a Nifty or Sensex ETF (exchange traded fund). An ETF is a passively managed fund which mimics Nifty/Sensex composition dynamically and charges a small fee for that.

So, how does this information help us? Let us assume that the average expenses of a middle class household are about 5 lakh rupees per year. Average inflation rate in India has been 8% for the last 35 years. Assuming, the same inflation rate is maintained, this household would need around 50 lakh per year 30 years from now to maintain the same standard of living. If the earning member of the family is about 30 years old, he still has 30 more years of working life left. If this family invests 5 lakh rupees in a Sensex ETF today, he would get 5 crore rupees thirty years from now.

We are assuming that Sensex will continue to deliver a CAGR of 17% return as India is expected to grow at 6% plus growth rates for a long time to come. Add to this the inflation rate of 6%. We have a scenario of nominal GDP growth of 12%. In such a scenario, it is fair to assume that corporate earnings and hence Sensex can grow at a CAGR of 17%.

However, let’s assume that India’s real GDP growth will slow down to 5% going forward, even then we can have a nominal GDP growth of 10%, assuming 5 % inflation. In this scenario also, the household will get 2.5 crore rupees after 30 years while his annual expenditure will only be 21 lakh. So roughly, a ratio of 1:10 for Expenditure: Savings is maintained, which should take care of household expenses in perpetuity with a basic fixed income investment approach.

Of course, this 30-year return does not come in a straight line. There was a lot of volatility over last thirty years with markets going up and down periodically and this will continue going forward. Investors have to stay the course through these upturns and downturns in the market. And yes, equity markets come with a lot of risk. Macroeconomic, geopolitical, political and currency volatility all add to the underlying risk and the investors should be cognizant of that. But then, there are no free lunches in life.

The key learning of this exercise is that a very basic equity investment strategy can take care of the total retirement planning of any household. This approach is hassle free. This is the best demonstration of the power of compounding. Unfortunately less than 5% of India households are invested in equity and thus miss out on this magical formula. It’s time we changed our investment habits for a happier and a prosperous future.

It would be appropriate to add at this moment that pension funds like Employees’ Provident Fund Organization (EPFO) and New Pension Scheme (NPS) should allocate a greater proportion of their investments into equities so as to harness the same power of compounding. This will also enable a lot more number of people to benefit from the stock market investments which they now seem to be indifferent to.

The writer is vice president & fund manager, PMS, Motilal Oswal Asset Management Company

Source : http://goo.gl/FxetbU

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