Why Equity is an Important Asset in Investment Portfolio?
Every one of us has one or the other financial goals and accordingly, we do our financial planning to achieve these financial goals. Our expectation is to earn maximum returns out of our investment portfolio and to do so asset allocation plays a major role. Asset allocation is nothing but another name for diversification. It is how we spread our investments across asset classes like; stocks, fixed income, property, gold, etc. Asset allocation ensures that “all the eggs are not in one basket”. Keeping high returns in mind, we should have enough equity investment in our portfolio to achieve higher returns. Generally, ‘Equity’ is closely associated with ‘Risk’. There are benefits of having ‘Equity’ in a portfolio. Equity helps in beating inflation, it also assists in portfolio diversification, give us an excellent return on investment in the Long-Term, regular income by way of “Dividends”.
Equity consistently earns a better rate than bonds over the longer term. Despite ups and downs in equity market, investors have earned a superior return if they are patient and are able to ride the downturn. The Indian stock market index or Sensex grew at a CAGR of approximately 16% per annum, since inception whereas on an average bond investments gives 7-8% returns. A major portion of our investment portfolio should be in equities if we want those higher returns. Although stock markets are volatile but if we are saving for long-term goals we can overcome stock market downturns. Historically, it has been observed that after every downturn, there has been a massive upside in the equity markets.
On the other hand, to beat the Inflation it is important to invest in equity. The price inflation for food has been around 8.5% over last 5 years. As we all know that the same amount of money will purchase less amount of food/goods in the upcoming years. To keep it up with the increase in inflation rate, investment in equity is one of the best choices. Moreover, most tax efficient among all the asset classes is equity. Rate of tax levied on Short term capital gains in equity investments is 15% while for long term capitals gains it is exempted. Dividends up to a limit of INR 10 Lakhs received by equity investors are exempted from tax and for dividends more than INR 10 Lakhs shall be taxed at the rate of 10% in the hands of the investor. Dividends paid are entirely tax free. Interest income from most fixed income investments are taxed as per the income tax act.
It is important to understand that, India is an emerging economy which was maintaining a GDP growth rate of ~7% before the pandemic. Although GDP growth went for a toss due to the pandemic situation but we can see the stock exchanges has already bounced back and standing on the previous position as it was before Covid. India has a huge young population which provides massive demographic advantage. A lot of families are expected to move into middle class and upper middle class, as per capita income is increasing continuously. Discretionary spending will increase. Government schemes like “Housing for all” and “Smart cities” will lead to capital expenditure by the government. Credit boost by government schemes like “Mudra Yojana” will help the economy grow. As a developing nation these factors will help to boost majority of sectors, and if the sectors performs well then the company and company stocks will perform as well.
Thus we can say that equity is the crown of all asset classes which drives your investment growth to such an extent which other asset classes struggles to reach. It definitely involves risk for which a thorough analysis and understanding own risk appetite is important before investing. Not having “equity” in our portfolio will not give our investment the opportunity to demonstrate its full growth potential and deliver a higher return.