Why the stock market is a good investment, and how it compares to alternatives

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When it comes to investing, the vast majority of Pakistanis think of gold, real estate and, occasionally,foreign currencies as investments. Some investors who are slightly more sophisticated may think ofgovernment bonds. Only a few dare to put their money in stocks. But the historical record demonstratesthat stocks are the best long-term investment and offer some of the best opportunities for increasing one’spersonal wealth for investment horizons longer than 10 years, and may even be appropriate for someinvestors looking to invest for a shorter time period.This article will lay out some of the ground rules of investing (a subset of personal finance) before movingon to the case for why (and how) you should invest in stocks.If the purpose of saving is to transfer one’s present earnings into the ability to spend money in the future,the purpose of investing is to ensure that the value of one’s savings do not get eroded by inflation andindeed grow faster than inflation.Since January 1958, the average inflation rate in Pakistan has been around 7.6% per year, according todata from the Pakistan Bureau of Statistics. While the past does not exactly predict the future, it offers auseful benchmark. Any investment you are considering should have the ability to beat that average 7.6%per year benchmark over a sustained period of time, even if it may not beat it in any given year.On that count, the worst investment would be to simply buy foreign currencies. Since January 1, 1999, theUS dollar has appreciated at an average rate of 5.7% per year, less than the inflation rate of 7.6% duringthat same period. Government bonds do better, yielding an average of 10.4% per year, oil yielding anaverage of 13.0% per year, real estate 14.3% per year, and gold 15.6% per year.But by far the best investment class was stocks, which yielded an average investment return of 19% peryear during that same period.To put this in simpler terms, if you had invested Rs10,000 each in January 1999 in dollars, governmentbonds, oil, real estate, gold, and stocks, the account with dollars would be worth Rs33,069 today; the onewith bonds would be worth Rs84,919; the one with oil worth Rs141,901; the one with real estate worthRs178,308; the one with gold worth Rs229,317; and the one with stock worth Rs434,448.In other words, it is not even close: stocks significantly outperform any other asset class over a longperiod of time.Of course, there is a caveat: stocks deliver these high returns because they carry relatively higher risk.Stocks are the second-riskiest asset class (behind oil), but the returns are significantly higher. Investmentanalysts have a measure for the risk associated with each asset class, as well as a measure for the risk-adjusted returns for each asset class called a Sharpe ratio.The risk-adjusted returns for Pakistani stocks has been higher than any other asset class since January1999, as measured by the Sharpe ratio.What does that mean? It means that stocks may have higher risk, but they compensate for that by havingeven higher returns.A caveat: stocks are not an appropriate investment for all investors. Older investors, particularly thoseaged 55 and above, should avoid stocks for the most part (with some exceptions), and even for youngerinvestors, stocks may not always be the appropriate investment for all their savings needs. For instance,investing in stocks may be appropriate for a young person’s retirement savings, but not for theiremergency savings fund.‘So what?’ you might be tempted to say. Why should I invest in stocks? Because investing in stocks is theonly way you can buy an ownership stake in companies that will form the backbone of the future growth ofthe Pakistani economy. Put another way: investing in stocks is a way to invest in the future of Pakistan.Here is how one of our founders explained stock investing to his father a few years ago. “Baba, tell me of a trend you see in the economy,” he asked him.He thought a few minutes and then said: “More people are using broadband internet.”“Okay, good. So if you think that trend will continue, which publicly listed company do you think will standto benefit the most from that trend? The answer is PTCL. So if you think more people will continue to signup for broadband internet and that many of them will do so through PTCL, you should buy PTCL stock.”His father then asked a different question: “Okay, but how can I invest in the boom in the lawn sector?Sana Safinaz and all the other major designers are not listed companies. Some of them are not evenregistered.”Our founder’s response: “Yes, but some listed companies do have a lawn business. For example, GulAhmed is one of the oldest brand names in the lawn industry and has benefited from the rise in interest inlawn. It is also publicly listed, so you can buy their stock.”In other words, investing in stocks is about observing changes in people’s behaviour and thenresearching which companies are providing the goods and services that will serve that change inbehaviour. This is not easy, however, and not everyone has the time to keep on researching stocks andideas for investment. And some people may not have enough money to buy several different stocks tobuild a diversified portfolio. In that case, we would recommend investing in mutual funds.At SmartRupee, we provide access to investments in stocks through mutual funds. A mutual fund issimply a fund run by a professional asset management company that holds shares in many differentstocks, which helps lower the risk of investing in stocks while still providing the relatively higher returnstypically associated with stocks. Mutual funds have the advantage of allowing investors to diversify theirrisk while being able to access a full portfolio of stocks for an initial investment as little as Rs1,000. Inreturn, the asset management companies that operate mutual funds charge an annual management fee,typically 2% of total assets under management for a stock fund.

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