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Suresh Krishnamurthy

Large losses suffered by investors in both stock and debt markets in 2004 may only engender a sense of fatigue. Investors, however, need to set aside such emotions and keep investing in order to build wealth.

THE world has changed dramatically for investors from the beginning of the year. Stock price indices are down nearly 20 per cent since early 2004. Prices of government securities, too, are down nearly 10 per cent from their highs.

Spiralling oil prices, rising inflation and north-bound interest rates do not augur well for stock and bond prices over the next few months, too.

Only small savings schemes appear attractive for investing. A type of fatigue and apathy appears set to affect investing in India. It may, however, prove to be a folly if retail investors stay away from their asset allocation for long.

Conforming to a suitable asset allocation pattern has worked well for investors in the past. The returns generated by some of the balanced funds in the past five years will tell you that. In future, too, it will prove rewarding for investors.

Adhering to asset allocation: Textbooks say that sometimes investing is all about sticking to basics. When the market is in grip of a bear hug and some more losses seem to be round the corner, emotion overwhelms investors. The easiest thing to do then, they feel, is to keep stashing away money into savings bank accounts, stop reading financial newspapers and stay away from investing.

That might work for you if you know when to get back to the market. Unfortunately, barring a few, most of us do not. That does not mean the less skilled cannot win in investing. They can do so, if they strictly adhere to a set plan even through turbulent times.

This set plan usually involves adhering to an asset allocation pattern. Asset allocation refers to the process of dividing a portfolio into asset categories such as stocks, bonds, real estate and gold. For Indian investors, asset allocation is mostly about dividing the portfolio into stocks and bonds. Young investors may set apart even half of their portfolio for stocks. Older investors may restrict stocks to less than 25 per cent.

If investors need to consistently stick to this asset allocation pattern, they also need to be bullish on investing. Is there a case for being bullish about investing, especiallyabout stocks? There is.

The case for stocks: Generally, stocks are associated with outsized returns and losses. In some portfolios, stocks delivered 100 per cent returns in 2003 and losses of 40 per cent or more in 2004 till date. It is such large fluctuations that force some investors to stay away from market.

If, however, you look at stocks as an asset class that provide returns that are two to three percentage points more than debt instruments offer, stocks make a lot of sense.

For retail investors, stocks need to be included in their portfolios, mainly because of their ability to outperform debt markets. By producing returns that are higher than what debt markets can give, stocks also help you beat inflation.

The present milieu of rising inflation is, as such, an appropriate time to put more money into stocks. The profitability of Indian companies and their performance in the past five years indicate that over a longer period of between three and five years, stocks will continue to deliver attractive two-digit returns.

Sure, the Sensex might dip down to 4,200 in a few weeks. That would be immaterial if, after holding for a period of five years and above, you can get ten per cent per annum from stocks.

That remains well within the realms of probability. If you get more, that would be a bonus. The prudent way to do it now would be to step up allocation to equity mutual funds with good performance records.

Building wealth: If, each year, stocks deliver 10 per cent and bonds deliver 7 per cent, then a portfolio that is divided equally between stocks and bonds will deliver an annual 8.5 per cent. That might seem too low to you. Bt it is not.

Suppose your annual incomes too increase at this rate and your savings each year rise at a faster rate of, say, 10 per cent. In such a scenario, a return of about 8.5 per cent will help you build considerable wealth and deal with inflation in key segments such as housing, education and healthcare.

The long-term scenario then does not appear all that bad. The case for being optimistic about investing is strong indeed.

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