Stocks vs other investments

Stocks compete with many other asset classes, starting from a rudimentary bank account to other advanced asset classes like currency futures. While diversification across asset classes is a good idea, no other asset class is more rewarding than equity.

Bank deposits and debt instruments (bonds and bond funds, Public Provident Fund, post-office deposits, etc.) give fixed returns and hence look safer than stocks, which can be highly volatile. Debt instruments were the previous generation's pet. Many of us still vouch by the sanctity of fixed income. The only problem is that you can't create wealth with debt. If you account for inflation and taxes, you may actually be losing money on it.

The main difference between debt and equity is that while the former stands for 'lending', the latter means 'ownership'. By investing in a debt instrument, you are effectively lending money to the debt issuer on interest. When you lend money, you can't expect to earn more than the interest rate. But when you invest in stocks, you become part owner of the business. If the business does well, your returns have no upper limit. Stock investments are a bet on the economy. If the economy is going to grow, stock investments, in general, should grow by that much rate. Good businesses can do even better than the economy and hence multiply your money manifold, something you can't expect debt investments to do.

For many Indians, real estate is the most 'respectable' investment. Don't fall for the stories that magnify returns from property, for they are flawed. Equities trump real estate on many counts: returns, ease of handling, transparency, tax treatment, liquidity, etc. Apart from these, real-estate investments often require large sums. Since most people don't have any idea about how to invest in real estate, betting with large sums could be highly risky.

Indians' love for gold has made them infamous in the world. While the use of gold as jewellery is still understandable, gold as an investment remains questionable. You earn no dividends from it; on the contrary, you need to spend on its storage if you hold it in physical form. It's worth is mostly notional. The metal is also to be blamed for the country's fiscal deficit because the country has to import it to satisfy Indians' insatiable appetite for it. No wonder the government has launched schemes to limit hoarding of gold. A lot of black money also sits in gold.

Analysing commodities, such as metals, oil and agriculture products, requires special knowledge and access to their supply-demand trends, which are not readily available. Even if they are, the data are generally old. To be sure, commodity derivatives are more suited as a hedging instrument than an investment tool. The producers and sellers of those commodities use derivatives to protect themselves from future risks. For the individual investor, dealing in derivatives is complex and risky. They can give you deep losses before you realise what's going on. Ditto with currency futures. They are complex, derivative-oriented products that should best be left to traders.

All this suggests that one should seriously consider equity investments for wealth creation. If picked well, stocks can do wonders beyond your imagination.