Many individuals believe that equity is a hazardous asset class to have in their investment portfolio. Their apprehension is not without reason. Equity investment is risky; you can lose a significant part of your capital during market crashes.

Despite the risk, you need equity exposure to achieve your life goals.

In this article, we discuss why equity investment is important whether you are a working professional or a retiree.

Why equity? As a working professional, you may be pursuing multiple goals. Your short-term goal, for instance, may be to buy a house. Your intermediate goal would be to meet your child’s college education. And your long-term goal may be to accumulate wealth to fund your retired life.

Assume your near-term goal has a time horizon of two years; your intermediate goal six years and your long-term goal twenty years.

You could simply invest in taxable bank fixed deposits to meet your short-term (two-year deposits) and intermediate goals (six-year deposits).

You could buy tax-free bonds with 20-year maturity to supplement your provident fund and public provident fund investments for your retirement goals. The problem is that the post-tax return on deposits is less than 6 per cent. So, you need a large investment capital to achieve your life goals if you buy only bonds. But you may be hard-pressed for cash.

After all, your current income has to support your living expenses and three life goals. That is why you need equity investments. The expected return on equity is higher than that on bonds. This means your required investment capital will be lower if your portfolio has a mix of equity and bonds.

What if you are a retiree? You would obviously prefer stable income products to meet your living expenses. So, why invest in equity?

If you invest only in bank deposits, you run inflation risk — the risk that your investment income may not be enough to cover your inflation-adjusted living expenses every year.

For instance, healthcare inflation is much higher than general inflation. This means healthcare costs in 2020 will be much higher than in 2016, but your bank deposits will earn the same interest income in 2020 as in 2016. So, you will be forced to redeem your deposits to meet higher healthcare costs.

Several such outcomes would mean that you would be depleting your investment capital. At the extreme, you could run out of money during your lifetime!

Equity can earn higher return than inflation, thereby reducing your portfolio’s inflation risk.

Alternative investments

You may well argue that investing in gold and real estate may fetch higher returns than bank deposits. So, why invest in equity? For one, real estate is immovable and illiquid. Real estate is better for retirees than for working professionals whose job requires them to be portable.

For retirees, real estate investment earns only rental income, not capital appreciation.

And rental income does not move in sync with inflation. Also, gold is just as volatile as equity. So, how is gold different? It performs well during economic crisis. So, whether you are a working professional or a retiree, you should invest in equity. You can, however, choose the allocation based on your risk appetite.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

Related Topics