Cairn is looking to invest Rs 100 bn and raise India's crude oil output to 500,000 barrels per day (bpd), or 25 million tonnes a year, surpassing the annual production of state-run Oil and Natural Gas Corp (ONGC). (ET)

Investing in FD's is a losing long term proposition

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Ajit Dayal discusses why investing in Fixed Deposits is not as attractive as investing in stock markets. With the equity markets in the "doldrums", there have been a series of articles in the popular press about how investing in Fixed Deposits and in bank accounts is far superior to investing in stock markets. As for gold, it is seen as some barbaric relic that only fools would throw their money at. These arguments are flawed and distort the facts. Readers of the Honest Truth are familiar with the table that is there at the end of every Honest Truth. Suggested allocation in Quantum Mutual Funds (after keeping safe money aside) Quantum Long Term Equity Fund Quantum Gold Fund (NSE symbol: QGOLDHALF) Quantum Liquid Fund Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information" Based on Table 1, it is obvious that investors should have exposure to various asset classes. The percentage allocated to each asset class may vary depending on the individual situation of the investors. At the end of the day any investment we make is for: Peace of mind - to know that the asset is there when you may need it; To meet our present consumption in the future years - assuming that inflation will increase the price of whatever we consume today, our savings needs to find a way to earna return to match - or surge faster than - the rate of growth in prices, To meet future good events that you know will occur - getting married, having children, educating the children, arranging finances for their marriage, and buying a place to live, To meet future problems that may occur - illness, a loss of a job, a loss of a key earning member of the family. Each of us will plan for the above in different ways. Some may believe that they will not get married. Some may feel that it is not their responsibility to educate their children through college or help in their marriage. Some may believe in renting a home and never buying a home. Our "goals" should determine how much we save and then how we invest those savings. Shilpa's choice But all of us have a "consumption basket" - we all consume things and, as long as we live, will increasingly consume things. The price we pay for our consumption basket is likely to increase over time - the effects of inflation. Let's take the example of Shilpa, a typical consumer and see how thecost of her consumption basket has changed over time (Table 2). The start year is assumed as 1990. That is just before the Great Indian Reforms of in 1991 when most services or products were provided by either government monopolies or by a few licensed private sector cartels. Table 2: Shilpa' s cost of living per annum CONSUMER BASKET 1990* 2000 2010 2011 Food and personal care (Grocery bill) 10,167 20,000 37,500 42,500 Taxis / Trains / Local air travel 3,696 8,750 11,250 15,000 Clothes, shoes 964 2,500 3,750 4,250 Going out (Recreation and Cultural activities) 402 1,250 4,500 6,250 Rent / Accommodation cost 10,000 40,000 70,000 80,000 Electricity 2,000 5,000 8,000 9,000 Telephone / Mobile phone bills 3,500 6,500 9,000 10,000 Medical expenses 2,000 5,000 6,500 8,000 Education 500 2,000 3,000 3,000 Electronic items 880 2,500 18,750 22,500 Holidays (Hotels and Restaurants) 8,805 25,000 50,000 62,500 TOTAL SPENDING PER ANNUM 42,914 118,500 222,250 263,000 Fully aware the costs of enjoying her consumption basket over time will increase; Shilpa knew she had to invest her savings. For arguments sake let's assume that Shilpa had 3 extreme choices: Invest all her savings in gold, Invest all her savings in the stock market via the BSE-30 Index, Invest all her savings in a Fixed Deposit with a PSU Bank. Table 3: You need less of "BSE-30 Index money' and "gold money" and more of your "FD money" to enjoy your consumption basket. CONSUMER BASKET 1990 2000 2010 2011 TOTAL SPENDING PER ANNUM 42,914 118,500 222,250 263,000 Price of gold, INR/10 grammes 2,145 4,012 17,940 23,544 Units ( Grams) of gold to consume my basket 200 295 124 112 BSE SENSEX 942 4,606 18,207 17,778 Unitsof BSE-30 Index to consume my basket 46 26 12 15 Fixed Deposit Basket Index Value (Value of initial investment Jan 1, 1990 =1000) (SBI 1 Year Deposit Rate)* 1,064 2,220 3,550 3,769 Unitsof FD Basket to consume my basket 40 53 63 70 * Quarterly compounding and Tax rate on Fixed Deposit assumed to be 30% As Table 3 indicates, the annual cost of her consumption basket in 2011 is Rs 263,000 v/s Rs 42,194 in 1990 - that is an increase of 613% in 21 years, an average price increase of 9% per year over the past 21 years. If Shilpa could use gold to pay for her consumption, she would have needed 200 grammes of gold in 1990. To maintain her "consumption basket" in 2011 she would need only 112 grammes of gold. This is so because the price of gold has surged by 1,098% over that same 21 year time period - an average rate of return of 12% per year for the past 21 years. This is higher than the increase of 9% in the prices of the items in Shilpa's consumption basket. If Shilpa could pay for her consumption with units of "BSE 30 Index" then she would have needed 46 baskets of the BSE-30 Index in 1990. To maintain her "consumption basket" in 2011, she would need only 15 baskets of the BSE-30 Index. This is because the BSE-30 Index has surged by 1,888% over that same 21 year time period - an average rate of return of 15% per year for the past 21 years. This is higher than the increase of 9% in the prices of the items in Shilpa's consumption basket. If Shilpa could pay for her consumption with units of Fixed Deposits or "FDs" then she would have needed 40 baskets of the FDs in 1990. To maintain her "consumption basket" in 2011, she would need a larger number of 70 baskets of the FDs. This is because, while the FDs may have given an average return of 6% after tax, they are below the nearly 9% increase in the prices of goods that Shilpa consumes. This is lower than the increase of 9% in the prices of the items in Shilpa's consumption basket. Note the risks But before you go rushing to buy equity shares or gold, note that both these asset classes can be in the dumps for a long period of time. Or, conversely, can also be "at peaks" for a short period of time. Changes in tax laws will also influence where people could save. If investing in FD's was to become tax free, then maybe Indians like Shilpa would see the benefit of investing in them. Similarly, gold may now attract an import tax and a wealth tax. Shilpa's consumption basket could change. But the biggest risk is, in my opinion, is not diversifying the surplus savings we have into a range of instruments that can give you a steady, decent return and an opportunity to live through some tough times. Disclaimer: The Honest Truth is authored by Ajit Dayal.

CONSUMER BASKET	1990	2000	2010	2011
TOTAL SPENDING PER ANNUM	42,914	118,500	222,250	263,000
Price of gold, INR/10 grammes	2,145	4,012	17,940	23,544
Units ( Grams) of gold to consume my basket	200	295	124	112
BSE SENSEX	942	4,606	18,207	17,778
Unitsof BSE-30 Index to consume my basket	46	26	12	15
Fixed Deposit Basket Index Value (Value of initial investment Jan 1, 1990 =1000) (SBI 1 Year Deposit Rate)*	1,064	2,220	3,550	3,769
Unitsof FD Basket to consume my basket	40	53	63	70

* Quarterly compounding and Tax rate on Fixed Deposit assumed to be 30%

"It is not the profit margins of the past but those of the future that are basically important to the investor." - Philip Fisher

However, is this right strategy to have? Certainly not if one is confident that the current growth rate in India is just an aberration and days of higher growth rate of 7%-8% are only a matter of time. In that case, there could be no better to time to invest in Indian stocks than now we believe.

And our belief stems from a study that we have carried out based on historical data. You see, since the year 1992-93, there have been only six financial years (excluding FY13) where the economy has grown below 6%. And investments made during the end of these years have on average yielded returns of 19% over the next 12 months. Even from a three year perspective, returns have averaged in the region of 17%. Thus, as can be seen, a weak economy is not the time to avoid stocks. In fact, investments made at such times are likely to yield the best results over the medium to long term as most stocks are priced poorly given the weak economic environment. Therefore, smart investors who are able to take advantage of this opportunity are the ones that end up creating good deal of wealth for themselves.

Consequently, one's best chance at generating returns does not lie in heeding Mr Feldstein's advice. It instead lies in taking an exposure in Indian equities if one is confident of its long term growth story.

Table 2: Shilpa' s cost of living per annum

CONSUMER BASKET	1990*	2000	2010	2011
Food and personal care (Grocery bill)	10,167	20,000	37,500	42,500
Taxis / Trains / Local air travel	3,696	8,750	11,250	15,000
Clothes, shoes	964	2,500	3,750	4,250
Going out (Recreation and Cultural activities)	402	1,250	4,500	6,250
Rent / Accommodation cost	10,000	40,000	70,000	80,000
Electricity	2,000	5,000	8,000	9,000
Telephone / Mobile phone bills	3,500	6,500	9,000	10,000
Medical expenses	2,000	5,000	6,500	8,000
Education	500	2,000	3,000	3,000
Electronic items	880	2,500	18,750	22,500
Holidays (Hotels and Restaurants)	8,805	25,000	50,000	62,500
TOTAL SPENDING PER ANNUM	42,914	118,500	222,250	263,000

"No one in this room or anywhere else knows where the price of gold is going next year or the year after. All we know is that the risks of owning it are fairly low...while the risks of not owning it are high."