One of the most effective ways of creating a good corpus is to diversify or go beyond the traditional avenues of investments. The stock market offers some good investment opportunities and there are multiple reasons why you should invest in the capital market for your future.
Let us understand these in detail:
- Power of compounding
Capital markets are a source of long-term capital for the government and for companies. They raise money by issuing stocks, long-term bonds and other long-term instruments. One of the key advantages of investing in the capital market is benefitting through the power of compounding.
What does compounding mean?
When an asset's earnings from capital gains, dividends or interest, are reinvested they tend to generate additional earnings over time, this is called compounding.
Let’s say you buy ABC shares worth ₹10,000 and they rise by 10% in the first year. Then your investment would be worth ₹11,000. If you hold onto the shares and they grow by 10% again the next year your ₹11,000 would grow to ₹12,100.
So, instead of your shares growing by just ₹1,000 (10%) like they did in the first year, because of compounding they will grow by an additional ₹1,100. Hence, investing regularly in such stocks could considerably help you create a large corpus over time.
- Return potential on equities
Globally, stocks have done well over long periods of time. Investing in well diversified portfolios of stocks has been rewarding for long-term investors. In the ten years ending 7th October 2021, the Nifty 50 total return index had given 15.5% returns and the flexi cap funds (equity mutual fund schemes that invest in stocks of companies of all sizes) have given 15.8% returns in the same period (as per Value Research).
In the same period, gilt funds (mutual fund schemes investing in government securities) have given 8.69% and gold funds (that track the prices of gold) have given 4.65% returns.
- Beating inflation
Inflation impacts consumers’ ability to spend. If you keep your money in a low-interest rate paying savings bank account or a short-term bank fixed deposit then your returns fail to beat the inflation. In this case, inflation eats into your purchasing power. If you leave money at home in cash to save up for a vacation in Europe, then after 30 years that cash may not even be enough for a small weekend trip.
To beat inflation, you have to look for investment avenues that offer returns in excess of the rate of inflation. Capital market offers you options such as stocks and some high-yield deep discount bonds that help you beat inflation. Since these can help you create a corpus large enough to maintain your lifestyle over a long period of time, you should be investing in the capital market.
- The ‘hassle-free’ factor
India’s capital markets are quite robust. Thanks to technology, investors can easily access capital markets and buy and sell shares, bonds with a click of a button. They can even access information related to companies easily. This saves a lot of effort, time and cost for investors.
- Well-regulated market
A robust regulatory framework that aims at protecting investors’ interest has attracted many investors in the Indian capital market. This has improved the demand for shares and bonds in the Indian capital market. As more investors join the tribe, investments in financial assets such as bonds, shares and mutual fund units are expected to go up. This has ensured that more investors prefer financial assets to physical assets such as land, real estate and bullion gold. Also, physical assets have limitations such as storage issues, risk of theft, risk of damage, encroachment and poor liquidity.
- Better taxation
Capital markets typically raise funds for the long-term and to attract investors, there are some incentives attached with such investments. One of these is a better rate of taxation compared to traditional short-term investments. For example, interest earned on a fixed deposit with a bank, is clubbed to your income and taxed as per slab rate. This hurts investors in high income-tax slabs. But gains earned on a sale of stock held for more than one year are treated as long-term capital gain and taxed at 10% if gains exceed ₹1 lakh in a financial year. A listed long-term tax-free bond is also tax efficient. Interest earned on such bonds is exempt from taxes. But gains on sale of bonds on a stock exchange after holding it for a minimum one year are treated as long-term capital gain and taxed at 10% without indexation benefit. - Become a part-owner
We consume many goods and services and appreciate brands for the value they add to our lives. By investing in such companies we are eager to understand more about their business model and also the factors that drive their demand and supply. In essence, we become part owners in these companies and are personally invested in their growth.
What to keep in mind while investing in the capital markets?
Knowledge is money: Making money consistently in the capital market requires research. To make money over the long-term you have to be familiar with businesses. You need to understand the business fundamentals of a few companies to make an informed decision to buy their shares. Your understanding of a business can help you invest in a business at the right price and stand a chance to make money.
Diversification: While investing, you should not put all your eggs in one basket. This means one should not invest all their money in one investment or in one asset class. They should diversify across stocks, bonds, precious metals and real estate. Such diversified portfolios can offer better risk-adjusted returns in the long term.
Fulfilling your dreams: Funds created from long-term compounding can help you fulfill your dreams or wishes. From buying a dream car, a large house to building a fund for charity, all your financial goals can be funded with the help of investments in the capital market.
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