Stocks provide the best return in the long term

When we buy a business, we try to look out and estimate the cash it will generate and compare it to the purchase price. We have to feel pretty good about our projections and then have a purchase price that makes sense. Over time, we have had more pleasant surprises than we would have expected.

Warren Buffet

Long term investing requires an understanding of the performance of various asset classes over an extended period of time. Traditionally, only two asset classes have existed – debt and equity. However, as investment options have extended beyond the capital markets, other options such as real estate, currency and gold have opened up and found favor with investors. 

Real estate is a practical investment option only for those investors who can afford a large ticket size, high transaction and switching costs, long holding periods and the risk of illiquidity. 

Currency markets are not meant for long term investors at all – rather they are meant as a means of hedging the exchange rate risk of businesses having income in foreign currency. 

Gold is a defensive asset class, since its primary objective is to serve as a hedge against inflation. Nonetheless, since Indians have an insatiable appetite for holding gold assets, we will consider it as an asset class for the purpose of this article. 

The following table shows the return from PPF (proxy for debt), Gold and the Nifty (proxy for equity) over 5 different time periods – ranging from 1 year to 15 years.

Date	PPF rate	Gold rate	NSE Nifty
1-Jan-02	9.50%	4274	1058.85
1-Jan-03	9.00%	5320	1093.6
1-Jan-04	8.00%	5989	1880.35
1-Jan-05	8.00%	6128	2080
1-Jan-06	8.00%	8400	2836.8
1-Jan-07	8.00%	10800	3128.2
1-Jan-08	8.00%	12500	6136.75
1-Jan-09	8.00%	13670	2963.3
1-Jan-10	8.00%	16665	5200.9
1-Jan-11	8.00%	20688	6177.45
1-Jan-12	8.60%	27322	4640.2
1-Jan-13	8.80%	30893	5937.65
1-Jan-14	8.70%	28430	6323.8
1-Jan-15	8.70%	26699	8272.8
1-Jan-16	8.70%	24966	7938.45
1-Jan-17	8.10%	27445	8210.1
Annual Return
1 year	8.10%	9.93%	3.42%
3 years	8.50%	-1.17%	9.09%
5 years	8.60%	0.09%	12.09%
10 years	8.36%	9.78%	10.13%
15 years	8.31%	13.20%	14.63%

As can be seen from the above data, debt returns are consistently above 8% over the long term and appear to be a good option, especially for risk averse investors. However, if we factor in inflation even at a modest rate of 6%, the real rate of returns from the debt market shrinks to a meager 2%. Clearly this is not enough of a reward for long term investors.

Turning next to Gold, we see that it has offered double digit returns over the long run. However, this is primarily due to price appreciation during the years 2006-2012 when inflation in India was quite high. As inflation has moderated in recent years, returns from Gold have stagnated, as proved by the 3 year and 5 year gold return data above. 

Finally, turning to equity we see that the Nifty has returned close to 15% over the long term. This is the expected long term return from Indian equities and it has also been established by numerous studies. At this level of return, the investor is left with a real rate of return of 9% after budgeting for inflation at 6%, which is a decent return for any long term investor. However, the Nifty is an index of the top 50 large-cap stocks in India – which by definition do NOT provide the most capital appreciation. That comes from mid-cap and small-cap stocks. Investing in equities can be very rewarding, but the challenge lies in picking stocks with a high return potential. That is where an Investment Advisor can help.

At Attainix Consulting, we have developed the icTracker software that assesses the Knowledge Assets (aka Intellectual Capital) of the underlying business every quarter. The reason for doing this is simple - Knowledge Assets provide long term competitive advantage to a business. These are the businesses with the most return potential especially if they have not yet been noticed by the capital markets. Back-testing of the icTracker shows that returns from such stocks can be easily more than twice the expected returns from the Nifty! Now, wouldn’t you consider that as an icing on your cake?