WHY Equities give good long term returns

Those of you who have attended any of my ‘Investor Awareness Programs’ may be already nodding their heads thinking that they know the answer to this above question. Yes. I have discussed the above question in my seminars at length and many participants have also appreciated the fact that my explanation was easy to understand and also logical at the same time.

Investors generally have an exaggerated fear of the stock markets in general, which is fueled by the media, whenever the markets fall. This has lead many of the investors to take shelter in traditional low return financial instruments – which at best can only protect their wealth, but cannot grow it in real terms. For many decades, stock markets (Equities) have wrongly been seen as markets where one can become rich overnight while at the same time investors seems to have erroneously invested for long terms of 10 to 15 years in low-return safe investments.

What actually was needed was to reverse the logic. – invest in equities for long term and invest in safe investment for short term. The reasons are not difficult to understand and you don’t need to be an economics or finance major to grasp the reasoning.

The FIRST reason why equities will give you high long term returns is the fact that when you invest in them for periods of more than 7 years to 10 years, you are actually investing in the ‘Indian economic growth story’. Thus when we invest in equities, we are investing in the fact that India is the second fastest growing economy in the world and that this $2 trillion economy is likely to grow to a $5 trillion economy in the next 7 to 8 years. We are investing in this growth potential.

The SECOND reason why equities are better in generating good long term returns is the very fact that they are volatile. Any asset whose price fluctuates in the short to medium term is likely to give much better returns over long period and by the same logic any asset whose price remain steady in the short to medium term will generate lower returns. Equities being the most volatile (except currencies and specific commodities) thus tend to give above average returns in the long term which can easily beat inflation and hence lead to actual wealth generation. Fixed income securities or safe investments, being least volatile , tend to be good only as short term investment vehicles and not long term.

I urge you to think over the above ‘economic’ logic and realize that equities are for long term investing and long term wealth creation.

I shall appreciate your comments and observations so that others can benefit too.

CA Rajiv D Khatlawala

Author, Consultant and FinTrainer.