Relation between Equity and Inflation.

Equity can make you financially comfortable in old age…

In India, people have a very strong impulse to save money in form of cash. This was evident at time of demonetization, often housewives or elderly person in home had stored large amount of money in form of cash. Notably this was not black money, it came from legitimate source which was just squirreled away by someone over many years. None of these people understood the compounding effect of inflation. All these people had just wasted their money as the relentless rise in price, there is some 5% to 10% depreciation in value of money every year.

Till 2000, Equity was for punting and for savings, one kind or the another of deposits were selected. In early days in India, 99% of savers had anti-equity view, this percentage is now down to almost 95%. The fact is that even savings invested in form of deposits whether its is in form of bank account or FDs or PPFs or anything else, it yields almost no real rates of return. The sole reason being the effect of inflation.

Those who depend on these kind of savings (in form of cash or some kind of deposits) for their old age income need much more savings in order to avoid hardship. For retirement one will have a very specific need that there should be income after retirement and this income should be inflation adjusted i.e. with the rising cost income should also grow. People other than those who have inherently inflation linked lifelong income like a lot of rents or perhaps a government pension, every other saver has only one meaningful way to do this, is by investing in equity.

To understand how one can defeat inflation in old age by equity investment, let us understand that there are only two basic ways of investing money – either lend your money to someone or you can own a business.

Lending money will fetch you a basic return but will not share in upside. On the other hand, owning business does a fair justice, but not everyone is good at owning a business. Fortunately, there is an option of stock markets where anyone can become owners (part-owners) in a business. This means investing in equity. Equity investment includes both buying shares or investing in mutual funds.

To understand how equity can generate income which is inflation adjusted, we should know that the ultimate source of profits in equity is the general growth in economy. The daily fluctuation in markets give us an illusion that the market is volatile. However, if we take a look at the equity markets once every years for 5 years, the markets give the following annualized returns: 6.5%, -1.3%, 81.4%, -0.7%, 12.2%. This means that on an average every 5 year the CAGR is almost 20% and the value of stock is inflation adjusted. This make it very clear that equity is right choice.

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