This age-old habit of investing heavily in gold and real estate has denied meaningful returns.
Indian retail investors invested around Rs 1.4 lakh crore in equity mutual funds in 2017. Yet, financial assets remained a very small part (5 per cent) of their overall wealth, most of which remains invested primarily in real estate and gold(88 per cent).
This age-old habit of investing heavily in gold and real estate has not only denied millions of Indians meaningful returns, but also prevented them from benefitting from the country’s steady economic rise over the past three decades.
For example, gold has given only 2 per cent return per annum on an inflation-adjusted basis since 1990. So, Rs 1 lakh invested in gold has become Rs 11.2 lakh in 2017. Had the same money been invested in the Sensex over the same period, it would have become Rs 35 lakh.
Real estate price data is patchy in India, but the long-term returns story for real estate is even more depressing in India. In the US, for example, where long run data is available, real estate has delivered a mere 0.4 per cent return per annum since 1900! If real estate did not deliver in the century in which the US rose to become the world’s greatest economy, we find it a little hard to believe that the outturn for this murky sector will be any different in India.
So, why do only 2 per cent Indians invest in the stock market, especially when Indian capital markets are well regulated and relatively tax-friendly?
Our research shows Indians’ love for physical assets over financial assets arises from: (1) The lack of sound financial advice, especially with regards to long-term financial planning for major events like retirement; (2) Lack of trust in financial institutions which have become associated with the misselling of complicated products, which have hidden charges; and (3) Lack of access to financial tools, which simplify the investment decision when faced with a plethora of choices.
As a result, investing in the stock market is seen as being the prerogative of wealthy Indians (business owners and institutions) with the general public – especially the middle classes – content to betting their hard-earned savings on illiquid and tax-inefficient asset classes like gold and real estate (which have high transaction costs to boot).
As advances in medical technology help us enjoy longer lives, it is important that we save carefully for retirement. Assuming that most of us will live for at least 25 years post-retirement at the age of 60, and assuming further that post-retirement a couple will need at least Rs 30 lakh per annum (post-tax) to maintain a reasonable lifestyle, even middle class families need to aim for a retirement corpus of at least Rs 10 crore. Worryingly, only a very small minority of Indians are investing in a manner that can help them build such a corpus.
A sensible investment plan can mean the difference between meeting these life goals and missing them. Rs 1 lakh saved every year in a bank account with an interest rate of 4 per cent per annum grows to only Rs 31 lakh in 20 years. The same amount invested at 15 per cent per annum (estimated long-term equity returns in India) becomes Rs 1.18 crore!
Clearly, ambitious life goals are more likely to be achieved by the latter corpus than the former one.
For the vast majority of investors in India, investment becomes a complicated affair partly because they are fed with incorrect investment theories by self-serving brokers and intermediaries. The most common myth spread by the wrong type of intermediaries is that “To make higher returns from the stock market, one must take higher risks.”
There are two tools that an investor can use to move from a ‘high-risk/low-return’ stock portfolio to a ‘low-risk/high-return’ stock portfolio: (1) ‘patience’ i.e. a holding period as long as 10 years; and (2) ‘quality of the underlying business’. To be more specific, ‘Coffee-Can Investing’ shows commitment to high quality franchises that consistently sustain their competitive advantages over long periods of time despite being faced with challenges and disruptions at regular intervals.
A portfolio of such companies, remains resilient even during periods of market stress, thereby generating consistent and healthy returns (substantially higher than the broader equity markets) with volatility of these returns being as low as that of a government bonds in the long run.
Whilst ‘Coffee Can Investing’ focuses on large well-established companies which have demonstrated sensible capital for a decade or more, another opportunity for a long-term investor is Indian smallcap and midcap stocks.
There are two reasons why smaller companies can outperform the broader stock market over extended periods of time: smaller companies have the potential to grow profits much faster than large companies and, secondly, as smaller companies grow in size, they get “discovered” by the stock market.
A judicious selection of smallcap stocks should give superior returns to investors. An important caveat here is that, because of lack of information and expert coverage, there are rampant quality and accounting issues in this space. Thus an average investor needs professional help whilst investing in small cap companies – something that our book highlights in the form of the ‘Good & Clean’ approach to investing in smaller companies.
Building long-term wealth to meet life goals is not a complicated exercise. A few hours spent on reading “Coffee Can Investing” will go a long way towards helping hard working professionals and business owners ensure that their financial needs are addressed in a systematic manner.
(Saurabh Mukherjea is CEO of Ambit Capital. This article is based on a research for his book, “Coffee Can Investing: The Low Risk Road to Stupendous Wealth”, which Mr Mukherjea has authored with Rakshit Ranjan, Fund Manager, and Pranab Uniyal, Head of Products & Advisory, Ambit Capital. The book will be released on February 23)