Let us understand the relationship between investing, inflation and growth with a comparative study of returns over the 35 year period between 1980 and 2015…
Asset Class CAGR 35-Year Return Average Inflation Real Return
Fixed Deposits 8.41% 7.57% 0.84%
Gold 10.82% 7.57% 3.25%
Silver 10.03% 7.57% 2.46%
Sensex 16.72% 7.57% 9.15%
Sensex with DY 18.72% 7.57% 11.15%
From the above table it is evident that as a long-term investment, equities have been the best way to create long-term wealth. This is the 35-year CAGR of returns and hence there is unlikely to be any short-term bias in these numbers. The Sensex (the benchmark index of the BSE) has given 16.72% annualized returns over the last 35 years without considering dividends and 18.72% annualized returns after considering dividends. So if you had invested a sum of Rs.10,000/- in 1980 in the Sensex and forgotten about it, that investment would be worth Rs.22.40 lakhs without considering dividends and it will be worth Rs.40.60 lakhs after considering dividends. That is the kind of wealth that investing in equities can create over the longer term.
It is clear from the above example that investing in equities; either directly or through mutual funds, can better inflation by a huge margin. The question, therefore, is why are equities able to outperform over a longer time horizon? The answer lies in participation in growth! As the legendary investor, Peter Lynch summed it up, “When you buy an equity share, remember there is a company behind it.” When you invest in an FD or a debenture, you do not participate in the growth of the company. On the contrary, when you invest in equities you participate in the growth of the company. Companies like Infosys, Hero Motocorp and HDFC Bank have consistently grown their businesses and as a shareholder, you will participate in their growth in the form of better valuations and higher returns. It is for this reason that the key to earning long-term returns on equity is all about growth. It is companies that are growing rapidly that always give the best returns to equity shareholders.