A Pre-Read to Getting Started on Equities.
As a wealth management professional any conversation with clients, friends, relatives, and casual acquaintances invariably includes the question- should they invest in equities?
The scope and length of my answer is a function of how well versed they are with equity instruments but there is one commonality on all the discussion that I have, reinforcement of basic characteristics of equity as an asset class.
Appended is a ready reckoner of what prospective investors in equities should keep in mind as they start their first SIP or add another SIP to their portfolio.
You are Investing in a Business : The word Equity refers to a Share in a Business. I would love to own a business that sells detergent soaps to every Indian. However, I do not have the resources to build one on my own, the next best thing I can do is to buy a share in Hindustan Unilever (HUL). If I buy shares of HUL or invest in a mutual fund that has shares of HUL in its portfolio, I end up as a part owner of a Business. I now Share the Risk that HUL encounters in the marketplace and I am Rewarded if HUL continues to be a Successful Business.
Business is a Risky Business : Look around and check how many successful businesses you see. From the entrepreneur who delivers your morning newspaper, to the grocery store where you shop and all the way up to Amazon. Each of these surviving businesses faced and surmounted difficult odds to get where they are today and even now, they faces Multitude of Risks. A business faces risk of getting the product and product delivery wrong, sudden, and drastic changes in the regulatory requirement and it operates in a complex and a dynamic world. Any of these risks can wipe out all the capital invested in the business. Success in business and Returns from are not guaranteed.
Non-linearity/ Uncertainty in Business : The world we live in is complex and has umpteen known and unknown variables. Here is a thought experiment- let us say your estimate of the time that it takes you to reach your office is 20 minutes. How often do you think you are able to reach it in 20 minutes in a month? Also, how confident are you of predicting how many times you will be able to make it to office in 20 minutes, every day, next month. Extrapolate this to predicting the certainty of an outcomes of a business venture. Business and investment returns are uncertain.
Vagaries of Stock Markets : The shares you buy are traded in the secondary markets. These markets have their own idiosyncrasies. Often you may find valuations of business do not match with the value you or your fund manager would give to business. As investors one must account for discount or premiums, the stock market may attach to your valuation of businesses. Historically successful businesses have shared their success with shareholders and created wealth for them over a 5-year cycle.
The aforesaid is an attempt to explain the background of the often heard statement- invest in equities for the Long Term. As the economies grow, they see businesses flourish and these flourishing businesses create wealth for their shareholders. India is a great example of these phenomenon playing out. In 1991 our GDP was about 0.3 trillion USD, today it is about 2.7 trillion USD- this has mirrored the growth of market capitalisation of listed companies in India.
But these businesses operate in a complex and dynamic environment and are valued in markets with another set of complexities. Investors will be well advised to take these factors in account as they start investing in equities.