Busting Indian Investment Myths

Yesterday, when a few of my relatives visited, they were chilling in the living room, watching TV. It was a relaxing evening; the adults were just chit-chatting about politics, cricket, and investments. To be honest, I like these discussions because I like to hear their perspectives about various things in life, especially investments. To eavesdrop, I frequently moved across the living room to the kitchen or sometimes just stood there and pretended to be using my phone. 

The adults made some points that were not the easiest to agree to, making me wonder. I started to think about whether they were correct or were just some myths? After thorough research, I concluded that all these points were myths in some way or another.

To better understand these myths, let us first understand how most earning Indians manage their money and how their investments are allocated.

India’s Wealth Distribution

In August 2017, the Reserve Bank of India published its 'Indian Household Finance Survey’

The report said:

“The average Indian household holds 84% of its wealth in real estate and other physical goods, 11% in gold, and the residual 5% in financial assets. Households in advanced economies hold substantially more financial assets than their Indian counterparts, are much more likely to finance home purchasing with a mortgage, and allocate a sizable fraction of their wealth to retirement savings over the course of their lifetime. The model also cannot explain the observed prominence of physical assets in middle age, exactly when the potential for the accumulation of financial wealth would be largest.”

Even worse is that the affluent Indians are investing in assets that fail to deliver a real rate of return, i.e. returns greater than the rate of inflation. The proactive marketing of investing instruments causes this debacle. As a result, the following myths are formed and perpetuated throughout the normal investing public.

Real estate will generate wealth.

It has become quite common for people to believe investing in real estate will make them rich. RBI's House Price Index reveals that the average return from owning housing real estate has been 11.6% annually for a decade. But in the last 5 years, i.e. 2015-2020, the returns from real estate have decreased to 5-6% annually. This, in tandem with inflation, generates no returns.

A handful of headwinds affect the RROR (real rate of return). First is the affordability of Indian residential house prices, or the lack of said affordability. According to 2020 data, housing prices in India are among the highest in the world. When expressed in House prices/GDP per capita, Indian houses are 6-10x costlier than countries in southern Asia.

Secondly, the rental yield in India is roughly 2-3% in most cities, whereas the cost of a home loan (interest) is 7-10%. This means you are losing money! Countries like the USA, Singapore, etc., have interest rates up to 3-4%. Now, add maintenance, broking, stamp duty, and other costs to the already high cost of finance mentioned above, and your returns go… poof.

Also, the returns from real estate depend on the location and timing. Lucknow's real estate returns were 16% annually, whilst Jaipur only managed to generate a 6% return annually. This doesn't mean that real estate won't generate any return.

The purpose of this study is to discover whether real estate will overpower equity investment, i.e. mutual funds, PMS, and stocks, or not. And averaging the returns, real estate doesn’t look too good.

Gold will fulfil your financial dreams.

As mentioned earlier, the RBI found that 11% of the wealth of Indians is stored in gold. According to Marcellus Investment Managers, over the last ten, twenty, and thirty years, the price of gold (in Rupees) has compounded at an annualized return of 9.2%, 12.7%, and 9.3%, respectively.

Over the same periods, an investment in the equity markets, represented by an investment in the BSE Sensex index, returned 10.4%/15.0%/14.8%, respectively, beating returns from gold at every time frame.

As per data, gold and equity positively correlate on the long-term horizon.

I can time the market.

No, you cannot. And except for some lucky fluke, no one could time the market. The market is dynamic and complex. A study in the US, done by the legendary Peter Lynch, looked at the 30 years from 1965 to 1995.

The study discovered that if one invested every single year in the market at its year low, one would have earned a return of 11.7% annually. If instead, you bought at the year's high, your returns at the end of thirty years would be 10.6 %.

And if you simply invested on the first day of the year, i.e. 1st Jan, not fretting about the price, your returns would have been 11%. Thirty years of data showed time and effort spent identifying the lowest market point each year was a wasteful act. The tedious activity amounted to just 0.7% more in returns than the simple practice of consistent investing.

Growth in the Stock market replicates economic growth.

In March 2020, the stock market fell by 40%, and by the end of the year, the stock market rallied and made a new high. From the bottom in March 2020, the market doubled. But did the economy grow? Did the economy double?

No. The economy tanked. Valuation guru Aswath Damodaran says that stock markets are predictors of GDP growth, not reflectors of GDP growth. The stock market is also a trading juncture where money is poured in, either by lending or investing your own, which affects the movements of stocks and indices. Primarily, speculations drive the market, which doesn't directly correlate with GDP growth.

The Bottom Line

So what's the solution? Equity investing. Sensex gave a compounded annual growth rate (CAGR) of 16.1% from 1979 to 2019. In the same period, gold’s return in Rupee terms was only 10%.

"Over the last 40 years, the Sensex has given a CAGR of over 17%, the highest return given by any asset class in India. It is a true reflection of the growth of India over all these years," said Ashish Chauhan, CEO of BSE. But does it mean it is undoubtedly the right approach to generate wealth via the equity method?

Numerous companies went bankrupt during these years. Remember Anil Ambani? His mega Reliance Power IPO? Satyam scam? Dewan Housing Finance? These companies displayed prominent financials, yet, they are worth zilch now. The Japanese and Chinese markets have not given any returns for 25-30 years and 15 years, respectively. Oh, and by the way, this also concludes that the 'buy and forget' investing hardly works anymore. Another myth busted.

The key while investing in the stock market is understanding a company. Analyzing a company's integrity and accounting practices becomes crucial to your investments. If the company's management or promoters’ method of operation is poor, no retail investors will be able to make money for themselves.

Understanding the company's future trajectory and competitive advantages will help you generate wealth. So, to generate wealth via stocks, one should invest in companies that are robust and are wealth compounders.

This article was inspired by the book - 'Diamonds in the dust' by Saurabh Mukherjea.