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Should you buy stocks now?
Sunil Nayanar |
July 21, 2003
Bull markets come and go, but the story of the retail investor follows the same script every time. When the market is about to take off, retail investors are held back by memories of the last bust.
But as the party continues, they allow greed to get the better of them. They enter the market just when the smart money is heading out. The crash comes after that.
Most of them lose their shirts, and retire to low-return fixed-income avenues to lick their wounds. Will it be any different this time?
The current bull market -- now 12 weeks old -- is again putting temptation in the way of retail investors. Should they yield, or say a firm no?
The answer to the question depends on whether you think the rally has some distance to run, or is about to lose steam.
When we asked some of the people who are actually interacting with retail investors, and even advising them, the answer seemed to be a qualified 'yes': equity is the place to be, but understand your risk appetite before plunging into it with your last rupee.
The backdrop to the bull run is clearly the positive trends in the economy and stock fundamentals.
The Sensex touched a 26-month high last week just as the rupee was hitting a three-year high. Average equity mutual fund returns for the last quarter are also at a three-year high.
Dividend yields in many stocks are at an attractive 5-10 per cent -- comparable with safer avenues. Gross domestic product is expected to grow at more than 6 per cent.
Investments by foreign institutional investors in the equity markets are zooming, with foreign funds pouring $554 million into the markets during June alone. Interest rates do not seem to have bottomed out, but may be close to doing so.
Add healthy corporate performances and expectations of a good monsoon this year, and the investment scenario in India looks good indeed.
A case for equities
Considering the conditions, what is the right strategy if you are a retail investor? According to an overwhelming majority of financial advisors, there is no getting away from equity.
"My advice to retail investors today is to go for equities," says Ambareesh Baliga, vice-president of Karvy Stock Broking.
"One can look at around 20 per cent returns from equity markets for a one-year period," he adds.
So what are the thumb rules?
"You have to set your financial goals and have a specific target in mind when you are investing in equity markets. You should do a proper asset-allocation exercise and only invest in equity markets what you can afford to lose if things go wrong," advises Baliga.
That may sound easy in theory, but the reality is different. "For small investors, lack of discipline is a major hurdle. Everybody wants to be rich instantly and ends up losing his hard-earned money at the end of the bull cycle," notes Baliga.
The crash at the end of the technology boom provides ample evidence. Most retail investors were carried away by the bubble in 1999, investing money in IT scrips despite unreasonably high valuations.
The failure to book profits resulted in most of them burning their fingers when the crash came in 2000-01.
According to Baliga, most investors are unwilling to take a long-term view on the markets. "There is no concept of long-term investment in India."
According to Harish Sabharwal, vice-president (western region), Bajaj Capital, an investment advisory and merchant banking firm, bad experiences of the past may be the overriding factor keeping retail investors away from equity markets.
For the majority, the lack of market know-how, time to research stocks and high risks act as a deterrent. So what is the next option? Equity mutual funds, says Baliga.
"If you want to avoid the risk of investing yourself, equity funds are a good option," says he. "We don't advice people to go directly for equities because the risk factors are high. We suggest equity diversified funds, which spread your portfolio, thereby minimising risk," says Sabharwal.
The worst seems to be over for equity mutual funds which were at the receiving end of redemption pressures following the market crash in 2000.
Most of these funds have generated over 20 per cent returns on an average over the last quarter. And, according to analysts, they have the potential to offer 18-20 per cent returns over a period of six months to one year.
While the attractiveness of equity funds lies in their diversification benefits, higher risk-adjusted returns and professional management, analysts warn that it is not a great idea to invest in funds showing the highest returns.
While sectoral funds may give better returns in good times, the losses could be just as big if things go wrong. That makes the case stronger for equity diversified funds, which have given 20 per cent average returns over the past one year.
There is an added bonus for investors in equity funds: dividends are now totally tax-free, as announced in the last Budget.
Despite making a strong case for equities, most financial advisors are careful to warn that it is your risk-appetite that must determine your decision to opt for them.
"If you are risk-averse, then you can look at debt instruments," says Sharad Shukla, head of investment advisory services at IL&FS-Investmart.
Is debt still worth it?
Investing directly in debt markets is still not a viable option for most retail investors.
Though trading levels on the wholesale debt segment of the NSE have seen a dramatic rise from a modest Rs 300-400 crore (Rs 3-4 billion) a day five years ago to around Rs 4,500-5,500 crore (Rs 4.5-5.5 billion) a day now, retail participation in this segment is negligible due to stringent trading requirements.
Moreover, debt requires as much knowledge as equity when it comes to managing risk as the impact of interest rate changes can be dramatic.
So most financial advisors advice investing in debt funds. "If you are a conservative investor, you should opt for debt funds which will give you 7.5-8.5 per cent returns," says Sunil Shetty, city manager, Bajaj Capital.
"However, one can't expect 12-16 per cent returns on debt instruments as was the case in the last two years."
Debt funds were the rage till very recently as declining interest rates and the weak performance of equity forced investors to look for other options.
Retail investors went into debt funds for their own reasons -- the relative safety of capital -- but were pleasantly surprised when they outperformed equity in terms of returns.
However, the situation is reversing as interest rates are set to bottom out while equity is yet to peak. "We expect a further 0.25 per cent cut in rates by RBI, but still the returns on debt funds cannot match their heyday," says Shetty.
Baliga agrees, "Though debt funds were in vogue for the last two years, they are unlikely to generate that kind of returns again, at least not in the foreseeable future."
Despite the downturn in fortunes, Baliga still believes that debt funds offer the best investment opportunity in this class, especially from a convenience point of view.
According to Shetty, over the past two years, the bulk of the returns in debt funds have accrued by way of capital appreciation; less than half has come by way of interest earnings.
With interest rates more-or-less stable, returns are expected to stay moderate.
That leaves risk-averse investors with few options apart from other debt instruments like post-office schemes, RBI relief bonds, bank fixed deposits and corporate bonds.
"Most of these schemes will ensure returns in the region of 7-8 per cent. Corporate bond papers rated AAA are also an option, but such papers are very few and liquidity is an issue," notes Sharad Shukla of Investmart.
"If one wants to invest in bonds, then you can expect 8-9 per cent returns (pre-tax) if you are prepared to take a little risk. On the other hand, if your risk appetite is low, then one can only expect returns of 7-8 per cent," concurs Baliga.
According to him, RBI bonds offer the best post-tax returns to small investors if one can lock in investments for a long period (five years for 6.5 per cent tax-free relief bonds and six years for 8 per cent savings bonds.)
What about the government securities (G-Sec) market? With interest rates declining, the opening up of the G-Sec market should have improved investments in this segment.
However, retail participation in the segment is negligible.
The problem with the market is that G-Sec prices tend to follow activity in the wholesale segment, thus making it risky and unappetising for small investors.
According to Baliga, one of the main causes for low participation in the debt market is that Indian markets have fewer instruments compared to developed markets. "The knowledge level about debt markets is also very low," he says.
That leaves us with good old bank saving accounts and fixed deposits. However, the rate of returns, at 3.5 per cent and 5.5-6 per cent, may not sound too good.
"People do require some safe investments like bank deposits, but these can't be expected to generate high returns," says Baliga.
For those who do not have taxable income, fixed deposits in banks or post offices are still attractive options.
Though the interest rates on popular post-office saving schemes such as time and recurring deposits, deposit schemes for retired government and public sector employees, national savings certificates, Indira Vikas Patras and Kisan Vikas Patras have come down, the schemes are still attractive for those who do not have taxable income.
The most preferred investment scheme for those in the highest tax slabs is the public provident fund.
What the pros say
But professional advice is to unlock your money from safe deposits and invest somewhere else. Firms like Bajaj Capital suggest different plans for small investors according to their risk appetite.
Bajaj Capital advises people who are very conservative to put 20 per cent of their investments in cash (including savings and short-term fixed deposits), 80 per cent in debt and zero per cent in equity.
For a very aggressive investor, the advice is to keep your cash at 5 per cent, debt investments at nearly 40 per cent and equity at more than 50 per cent.
If you want to choose the middle path, the ratio is 10 per cent, 70 per cent and 20 per cent respectively.
As things stand, some financial advisors are advising people to invest directly in equities -- if they are disciplined. "Retail investors cannot expect decent returns in avenues other than equities. But they have to maintain discipline," says Baliga.
"You should decide what you want to achieve and then stick to those objectives and targets, whatever be the temptation. If you are in it (equity) for the long term you should learn to ignore the short-term fluctuations of the markets, which are inevitable. And if you are trading short term, don't forget to keep stop-loss and target-profit levels," he advises.
However, Sabharwal is more cautious. "Even though we are expecting the equity markets to go up further, we advice people according to their budgets and risk appetites. Even though an equity investor can aim for 20-25 per cent returns, we believe the risks are too high for retail investors who want to invest directly in the markets."
According to Shukla, "One should look at the time horizon and financial liabilities before making an investment plan. If your risk appetite is high then you can invest up to 50 per cent of your money in equities, which can give you returns in the range of 15 per cent."
"Our advice to small investors is to have a three-year horizon if you are investing in equities and book profits at an appropriate time," he says.
Primary markets are an attractive option, too. "The IPO market could see some action due to the excellent response to the listing of Maruti," says Baliga.
To sum up, what the professionals are saying is this: if you have the stomach for it, then go for equities -- in particular, equity diversified funds, where you can spread your risk. If not, spread your investment between equity and debt.
What kind of an investor are you?
1. What is your main objective as an investor?
- (a) Safety of my principal
- (b) Earning returns above the inflation rate
- (c) Earning high returns
2. My current portfolio includes mainly. . .
- (a) Government securities and bonds
- (b) Mutual funds and company FDs
- (c) Equity shares
3. I would like my investment to grow. . .
- (a) Steadily
- (b) At average rate
- (c) Fast
4. How long have you have investing?
- (a) For last 1-5 years
- (b) For last 5-10 years
- (c) For over 10 years
5. What percentage of your income do you invest?
- (a) Up to 5%
- (b) 5%-10%
- (c) More than 10%
6. My knowledge about various investment schemes is:
- (a) Nil
- (b) Average
- (c) Good
Give 10 points for every 'a', 20 points for 'b' and 30 points for 'c'.
Your risk profile
- 60-120 : Conservative
- 121-150 : Moderate
- 151-180 : Aggressive
Adapted from Bajaj Capital Centre for Investment Research.