Sunday, July 11, 2010

In case you missed this good story in Business Line today

Investing in stocks is the best bet to beat inflation

20-year analysis shows returns outstrip gold, bank deposits and commodity futures.

With prices rising at double-digit rates, where does it pay to invest? An analysis of stock returns over alternative avenues of investment such as gold, bank deposits and commodity futures shows that equities have been most successful in giving inflation-beating returns.

Over a 20-year period, according to the analysis, equities have managed a higher return compared to other asset classes during years of high inflation (Consumer Price Index in excess of 7 per cent).

The Consumer Price Index has been above 7 per cent annually in all the years since 1990. Equities have managed to out-perform other asset classes for six years during the period.

In 1991, when the Consumer Price Index rose above 14 per cent, equity investors made an 80 per cent return (measured by Sensex) on their investment. In 1997, when the CPI rose over 7 per cent, the equity market delivered a close to 20 per cent return. In 2009, when inflation was at a 10-year high of 11 per cent, investors could have raked it from the market had they only been venturesome enough.

Equities outperform

In the years when the inflation was over 7 per cent, returns from equities oscillated between 17 and 80 per cent. Adjusting for inflation, the real return has been at least eight percentage points higher. The reward for investing in equity has also widened in recent years.

An investor who bet on equities, rather than gold in the last five years, generated a 12-percentage-point higher return compared to the eight-percentage-point excess return in the mid-1990s. Needless to say, the equity returns are much higher than the returns on investments in bank fixed deposits too. Interest rates on fixed deposits have fallen sharply since the mid-to-late 1990s.

Gold was the second best choice for hedging against inflation in the last two decades. In 2008 and 2009, for instance, when inflation was over 10 per cent, gold yielded a 15 per cent return.

Gold as choice

Gold has caught investor fancy only in the last seven years. Perceived as a safe-haven in times of crisis, the investment demand for gold has been going up.

The data of the past 20 years, however, do not throw up any precise trend of gold being an out-performer in inflationary times.

Indeed if it outshone stocks, it was only when there were external shocks such as the one that happened in 1997, and more recently in 2008, when there was a crisis of confidence with the equity market across the globe. The conservative investors who preferred the fixed deposit route to investment saw negative real returns in most of the years of high inflation.

In 2009, the interest rate for deposits of one-to-three years was 7.25 per cent, with negative real return (factoring in the inflation rate) of 4 per cent.

This year, too, as inflation continues to remain at 12-13 per cent, bank FDs offer interest rates of 6-6.5 per cent.

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