Mar 18, 2014
They inculcate discipline in investors, help negotiate volatility in the long run.
At the very basic, wealth creation refers to the process of deploying your money in a manner that there is real-value accretion over the long run. In other words, you should deploy your savings in such a way that the rate of return on your money beats the rate of inflation.
For example, today you spend Rs 100 to buy Product A. Now the rate of inflation in the economy is, say, 8% per annum. So we can assume that one year from now, the cost of the same Product A will be Rs 108. So to create real value, you should deploy your Rs 100 today in such a way and in such products that after a year, after paying for taxes if any, you should still have more than Rs 108. If your savings after one year is just Rs 108, you have not created any value, while if the value of your savings is less than Rs 108, you have actually destroyed value in real terms.
The idea here is to invest in such a way that your purchasing power is always more than what the rate of inflation is able to destroy. It is true that you may not be able to beat the rate of inflation in the short term, like in every year. But the aim should be to beat the inflation rate over the long term, that is over 10, 15, 20 years.
In India, over the past several years, stocks, gold and real estate have beaten the rate of inflation, while instruments like bank fixed deposits and bonds have not been able to do that in any significant way. So financial planners advise their clients, who are not very financially savvy, to take the equities route for wealth creation with some parts of the money going into debt, gold and real estate.
The illiquidity factor attached to real estate — which is your not being able to sell your property exactly when you need the money and also at the right price — is one of the most limiting factors for any decision to invest in this investment product. And for investing in equity and debt, financial planners advise their clients to take the mutual fund route.
For example, according to a note prepared by Bhavin Sangoi and Bhuvana Sreeram of Ffreedom Financial Planners, in the last five years, a portfolio of five mutual fund schemes — consisting of four equity schemes investing in large-, medium- and small-cap stocks and one debt scheme — returned about 12.70% on a compounded annual basis. So a systematic investment plan (SIP) of Rs 10,000 every month for five years in these funds amounted to about Rs 8.3 lakh. In comparison, if the same Rs 10,000 was put in a monthly recurring deposit for five years, the total corpus would be Rs 7.44 lakh, the note shows.
And this return in the mutual funds came despite the fact that the stock market has mostly remained flat on a point-to-point basis over this five-year period. "The important thing here is to invest regularly and stay away from reacting to market volatility. Undisputedly, mutual funds are a great wealth-creation vehicle," the note by Sangoi and Sreeram says.
To follow this route, financial planners and advisers say that the SIP route to invest in mutual funds is the best way: It inculcates discipline in one's approach to investment, helps the investor negotiate volatility and has a strong potential to create wealth in the long run.