Hey buddy you have no choice – if you do not have equity in your portfolio, Man, you are DEAD!

You would hate to hear this if your financial adviser (financial product salesman) were to tell you, but it is the truth.

You have no choice in seeing where to invest for people looking to hedge against the risk of higher inflation.

Real estate is fine under ordinary circumstances. Internationally real estate is on a death spiral and in India the housing market is in a bad spiral right now. And we may still be away from the bottom.

The old relic – gold – is another good choice, usually. But gold has already appreciated from just over $300 an ounce six years ago to almost $1200 today. It could be a little late, or we may at best match inflation.

And RBI Bonds yield much lesser than inflation! Assuming inflation to average 10% p.a. RBI bonds yield you about – 4.6%. That is an awfully steep price to pay!

So, hey Charlie, where can you put money to work today to hedge against the risk of higher inflation?

In shares, as the Englishmen call them or stocks, as the Americans call them. Frankly, do you have a choice? No. Nyet. Nay.

This may seem counterintuitive at first. After all, inflation devalues corporate earnings, the major driver of stock prices. But the mere presence of inflation also indicates that many companies are successfully passing along price increases to customers. This allows stocks to rise even when inflation in climbing.

During inflationary times in India – say during the 1970s and the 1980s stock market indices rose faster, much faster than inflation. And while the average rate of inflation throughout the 1980s was uncomfortably high.

An American analysis found that in inflationary periods – as measured from troughs to peaks some 6 of 10 market sectors in the S&P 500 actually gained ground.

So don’t let anyone persuade you that you should sell all your shares and invest that dough into precious metals, commodities, and real estate. Sure, these asset classes should make up a portion of your portfolio, but certainly not the bulk of it. If you use a Core and Satellite kind of strategy for your portfolio / asset allocation Equity has to be the Core.

Dr. Jeremy Siegel, author of Stocks for the Long Run, has done a study of the returns of different types of assets over the past 200 years.

What he discovered is dramatic. $1 invested in gold in 1802 would have been worth $32.84 at the end of 2006. The same dollar invested in T-Bills, with interest reinvested, would have grown to $5,061. $1 invested in bonds would be worth $18,235. And $1 invested in common stocks with dividends reinvested – drum roll, please – is now worth more than $12.7 million. Even adjusted for the 2008 crash, equities still stand head and shoulders over the other asset classes by a mile. And we are talking passive investing – no Vallabh Bhansali or Ken Fisher to help you get better returns.

The odds are good, of course, that you weren’t around a couple hundred years ago. And, you won’t be around 200 years from now, either.

It’s not necessary to think that long term, however. Start whenever you want and you’ll find that when measured in decades the investment returns for different asset classes are remarkably consistent. Stocks are the big winner.

Since 1926, the stock market has generated a positive return in 59 out of 82 calendar years – or nearly three out of every four years in the US of A.

Since 1980 your investment of Rs. 100 had become 21000 till 24 months back and is now at 17,800. And apart from this you got good dividend returns too! This by any stretch of imagination is a great return.

For the past 200 years, nothing has come close to matching the long-term compounded returns of equity shares. However, it is necessary to remember that this has happened only in democracies. So go out and vote and hope that over the next few years of your life we are able to preserve the democracy. If you make sure that the democracy survives, markets will make money, all you need to do is ride it!

We have no clue as to which other asset class can match equity returns! Like always invest systematically in a large index Exchange Traded Fund.