Recently, Mona caught up with her friend Priyanka who shared that her investment of Rs 1 lakh had more than doubled to Rs 2.25 lakh in three years.

Three years ago, Mona and Priyanka were both Area Sales Managers at a popular multi-national retailer. Both were star performers and had received Rs 1 lakh each as an incentive for achieving their sales target in the previous quarter.

Being good friends, they discussed on how they planned to invest their earnings. Priyanka had learnt about mutual funds from her husband, who worked at a reputed investment advisory firm. Knowing about the risk and benefits, along with the return potential, she advised Mona, too, to invest in the same equity mutual fund her husband had recommended.

( Read here to know the 10 basics about mutual fund. )

Priyanka had benefitted from investing in an equity mutual fund that earned her a compounded return of 30% compared to the 8.50% annual return earned by Mona through her bank fixed deposits.

As much as she hated to admit it, Mona envied the returns Priyanka had made. She would have earned the same returns too, if she had listened to her friend three years ago. Much to her own dismay, Mona’s investment of Rs 1 lakh grew to Rs 1.28 lakh in three years, pre-tax.

The difference in the value of their investments was nearly Rs 1 lakh.

Mona began to resent her decision and started imagining how she could have spent the additional Rs 1 lakh had she earned it.

Three years back, when Mona had the option to choose her investment avenue, she was apprehensive of investing in equity. Primarily because, she hadn’t invested anywhere other than bank deposits before. Even though Priyanka had explained to her all about equity diversified mutual funds, the fact that the returns were not guaranteed, cast doubts in her mind.

Mona was ill-prepared for the uncertainty.

Could she hold herself responsible for this decision, thought process, and approach to investing? They say experience is the best teacher, and Mona learnt a valuable lesson.

Most individuals by nature are risk averse.

Primarily, it is the dreaded thought of losing your hard-earned money. Therefore, even though equity mutual funds are expected to earn double-digit returns over 15 years, that is ignored owing to the risk involved.

Bank Fixed Deposits are a preferred route for most, even though the interest is taxed and the returns are unable to beat inflation.

Most who are hesitant to invest in equity funds have just one question: What is the guarantee that equity mutual funds will generate wealth over the long term?

While one cannot guarantee or predict stock returns, over the long-term, it’s proven that equity as an asset class generates respected tax-efficient returns over the long-term as the industries do well, companies grow, become profitable, and as the economy expands. This is the primary reason why businesses are established. Companies with strong fundamentals and a virtuous business model will generate immense value for their shareholders over the years.

Therefore, despite several market crashes in the past, the stock markets have always recovered and generated wealth for investors.

What you need to do is….
 

• Focus on the real returns
  
  Over the long-term, equity mutual funds are effective in beating the inflation bug. Meaning, they hold the potential to clock a decent real rate of return (also known as the inflation-adjusted returns).
  
  Historically, inflation has been in the range of 6-7%. Based on historical prices, equities have given a return of 12%-18% and even averaged above 20% per annum during the period 1980 to 1996. Given that equities can deliver a return of 12-15% p.a., your equity portfolio will beat inflation, delivering a healthy 4%-7% post-tax, post-inflation, real returns.
  
  However, the key here is selecting best mutual fund schemes and having an investment time horizon of at least 5-7 years.
   
• Tax benefits
  
  Unlike most fixed income products, the long-term gains (for a holding period over 12 months) earned on equity mutual funds are tax-free. Hence equity as an asset class is said to be tax efficient.
  
  In addition to this, investors looking for tax-saving avenues can invest in Equity Linked Savings Schemes (ELSSs). Here, you can claim tax benefits under Section 80C of the Income Tax Act; the amount invested is eligible for deduction from the gross total income, subject to an upper limit of Rs 150,000 in one financial year. Investments in tax-saving funds are subject to a 3-year lock-in period.
  
  On the other hand, the interest earned on a bank FD is taxable i.e. added to the total income and taxed as per the individual’s tax slab.
   

(Read here to know more about the benefits of investing in an equity-diversified funds)

The bank FD has matured and Mona has the option to renew it at the present 6.25% p.a. interest rate or redeem it and invest elsewhere. With interest rates have been heading lower over the years, there is no doubt, what has Mona decided to do.

But much to her surprise, Priyanka cautioned her from investing the lump sum amount in equity. The markets are currently hitting new highs and commanding extreme valuations, Priyanka told Mona. This makes investing in equity now highly risky. Hence, she advised her to invest in a debt fund and transfer the amount to the equity fund through a Systematic Transfer Plan (STP).

Just like having lifelong friends, staying the course with good investments can leave a person richer cerebrally and financially.

(Read here to learn about the 10 mistakes to avoid when investing in mutual funds )

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