Dec 12, 2012

FD's vs Equities- A Rejoinder

Dear Mr. Gomas,

Thank you very much for sharing Mr. ARK’s mail with me. It was a very informative piece and I appreciate Mr. ARK’s efforts.

One is wealthy when one has more than one requires.  If you require Rs 1,00,000 and you have 5,00,000 you are wealthy- plain and simple.  

Mr. ARK has strong and valid points. However, he has ignored something very important which I would like to highlight by means of a story.

Mr. Natwar sold a piece of land and made Rs 1,00,000/- in 1996. I’m sure you will agree that 1,00,000 was quite a sum in those days. He had no requirement for the money immediately. He decided to ‘invest’ the money for his daughter’s higher education in 16 years by investing in a bank FD.  

Fast-forward to 2012 and Mr. Natwar’s corpus is around Rs 3,42,600/- (@8% compounded p.a. and non-inclusive of taxes).  The corpus has more than tripled- smart investment it would seem. So what is the value of this investment in present terms? Mr. Natwar can still afford his daughter’s education but maybe not the best as he would have liked.

In 1996 Mr. Natwar was wealthy- but in 2012 he just about meets his requirements. In other words Mr. Natwar’s wealth has remained the same or decreased. Inflation has eroded the more than three time jump in his corpus.

FD’s are investments that protect your wealth, not grow it. This is fundamental to understand. If you want to remain in the same place then yes- invest in FD’s. Makes sense as there is no risk. But if you want to grow your wealth- then we have to look at other alternatives.

Equity, real-estate and gold are assets where there are no fixed returns. No one can say what the value of these assets will be tomorrow, in 5 years or in 10 years and that is exactly what the risks are with these investments.

I will cite real estate and gold as examples as I go further. You may be more familiar with these assets.  Gold has moved up considerably over the past few years. But, had you bought gold 3 months back @Rs 32,000 per 10 grams (on 14/9/2012) then today(@ Rs 31,455/-) you are sitting on a loss. With real estate too we have a similar story. Prices have remained more or less stagnant for the past 2-3 years. Had you invested 2 years back and were selling today you won’t be making much of a profit if at all. Everyone is buying on the assumptions that these assets will move up. But, when and by how much we cannot say.

This is exactly why we call these ‘long-term’ investments. Had Mr. Natwar invested his Rs 1,00,000 in gold, real estate or even in equity- he would have made much more than what he made through FD’s. But, there is the risk of not knowing what returns he will get and when he can/should sell. It might be that when he has his requirement the asset might not be properly priced. He will have to be smart and sell when he gets a good price. He might need advice for this. And that is what exactly I’m here to provide him.

The rewards for being able to accept risk and plan around it are well worth it. An investor has to understand this fundamental insight without which no investment is possible. If you want to grow your wealth you will have to take some risk. If you are content with your wealth and are comfortable with the knowledge that there is the possibility of it being eroded due to inflation then FD’s are the ideal investment for you.

Mr. ARK has quoted the case of Japan. Along with equities the prices of real estate have also came crashing down.

Gold also was on its way downward in yen terms till about 2000, when globally the prices of gold started to increase.

This is precisely why we had the depression in Japan. The economy shrunk because of the fall in value of assets. A bank FD in Japan currently yields 0% (Please check graph below).

I’m sure you won’t consider that as an investment for wealth creation whatever the circumstances. 
I hope this has cleared your understanding of what an FD is and where it stands in respect to other asset classes. I’ll be happy to clarify your doubts.


Recommended reading for further understanding:

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