“I don’t believe in equity; I only believe in real estate,” Rahul stated during a conversation I had with a group of business owners and retirees. Another individual chimed in, saying, “I am not very lucky with equities, so I invest in gold and fixed deposits.” Then there were some statements like these ones:

“I’ve heard too many stories of people losing their life savings in the stock market. I can’t afford that kind of risk.”

“I just don’t understand the stock market. It feels like gambling to me.”

“My friend invested in stocks and ended up in a financial mess when the market crashed. I don’t want to be in the same situation.”

“I prefer real estate; it’s tangible, and I can see my investment. Stocks are just numbers on a screen.”

There are many more reasons that people tell themselves and others for not investing in equity. In this post, I will tackle the comment that Rahul and the other gentleman made as I want to get across a powerful insight that is missed by most people.

But first let’s understand some basics…

What is equity?

When people think of equity, they think of the stock market and stock prices.

Don’t you?

Most people refer to equity as investing in the stock market and purchasing stocks or equity mutual funds. The focus is always on stock prices, the stock indices, and the daily movements of stock prices. While we do this, there is an important thing we forget – the real definition of equity.

In simple words, equity means ownership of an asset…This asset could be anything…even a house (home equity). In the context of the stocks, equity means ownership of a public company or a private company. And the stock market is then a place to become an owner of public companies. A mutual fund is an investment to become an owner of a diversified portfolio of companies.

So, when you invest in equity, you are essentially becoming an owner…When you invest in a mutual fund, you are becoming an owner of a diversified portfolio of large, mid, and small companies (or any combination thereof).

Equity then is not just equal to stock prices or its volatility (but that’s how we think about it in our minds). It represents real ownership which goes beyond stock prices. Owners don’t generally sell when their stock prices go down. On the other hand, they buy wherever they can.

I can write more but I might digress a bit. It’s best that I stop here with the simple definitions.

The insight that most people miss is this – Equity has to do well for every other asset class to do well.

Print this statement and staple it somewhere you can see every day – Equity has to do well for every other asset class to do well.

Now before I proceed, let me add a simple disclaimer or brief explanation: This does not mean that, if the stock market is down or negative in any year, other asset classes cannot be up or that they will be down.

Before your mind starts racing…let me ask you a few questions for you to reflect on…

Will real estate have value if the stock market does not do well?

Your answer here might be – Obviously, it will have value …It is tangible, and people need places to live. They can’t live in the stock market. Hard core real estate enthusiasts like Rahul will certainly echo this. And this line certainly seems logical until I write the next few lines.

But people need money to buy houses…People need money to live in houses too…People need money to pay their bills…

Now if equity (ownership) represented by all the businesses (not only public but private too) in a country does not do well… will people do well? (This is different than a stock market not doing well in the short term…)

Will people have jobs? Will people have the income to buy real estate or for that matter gold?

How does it matter that you have Rs.100 Crore worth of real estate or gold if people don’t have the money to buy these? If businesses are not doing well, in short this means that the economy is not doing well… It’s likely in a recession. Things might be gloomy everywhere…In scenarios like this, will real estate or anything have value…even if they have value, will there be demand for this and will you be able to sell it…

The point here is everything is connected…

If businesses don’t do well…no one has the money to save, spend, and invest. This has repercussions on every industry from banking to consumer goods to housing to hospitality, travel (and many others).

The point is businesses have to do well for people to have money… and businesses doing well mean rising corporate earnings and rising corporate earnings mean rising stock prices.

And as former Fed Chairman Ben Bernanke pointed out, “Both humanity’s capacity to innovate and the incentives to innovate are greater today than at any other time in history.”

The world is indeed making progress because of capitalism (despite its shortcomings) and equity ownership.

Understanding the intrinsic link between equity and the health of various asset classes is crucial for any investor. This insight often eludes many, as they grapple with the volatility (that’s visible) and the abstract nature of stock ownership. However, it is this very ownership in businesses — be they public or private — that forms the backbone of our economy. Without successful businesses, there would be no jobs, no disposable income, and, by extension, no market for real estate or other assets.

Let’s consider Rahul’s preference for real estate. It’s an understandable inclination — after all, real estate is tangible. You can touch it, see it, and derive utility from it. But real estate’s value doesn’t exist in a vacuum. It is inherently tied to the economy, which is fueled by businesses — the very entities represented by equity. If businesses falter, the repercussions are felt across all asset classes, including real estate. People need incomes to pay rent or purchase homes, and these incomes are largely derived from businesses thriving and growing, directly tied to the performance of equities.

Similarly, for those like the second gentleman who prefer the solidity of gold and the perceived safety of fixed deposits, it’s important to remember that these too are not immune to the health of the broader economy. Gold often serves as a hedge against inflation and economic uncertainty, but its price is also influenced by the performance of businesses and investors’ confidence in the economy. Fixed deposits offer a stable return, but the interest rates offered are affected by the economic environment, which is influenced by the success or failure of businesses.

In essence, all these asset classes are interdependent. While fixed deposits and gold might seem disconnected from the ebbs and flows of the stock market, they are all part of an interconnected financial system. The interest rates for deposits are often set based on expectations of economic growth and inflation, which are, in turn, influenced by how well businesses are performing.

Investing in equities is not merely a speculative play on numbers; it’s a stake in the economic vitality that sustains all other asset classes. This is why equities are essential and why their performance is a bellwether for the health of the economy and, by extension, the real estate market, the value of gold, and the viability of fixed deposits.

To truly understand the nature of investing, one must look beyond the superficial characteristics of each asset class and recognize the underlying economic forces that bind them. Equity is the lifeblood of these forces, pumping the necessary capital into businesses that drive innovation, employment, and wealth creation. Without a strong equity market, the entire financial ecosystem could suffer, diminishing the value and returns of real estate, gold, and fixed deposits.

Therefore, for individuals like Rahul and the second gentleman, while diversification across asset classes is a wise strategy to mitigate risk, it’s also essential to appreciate the role of equities in underpinning the overall health of the investment landscape. An informed investor should recognize that equities are not just about the potential for returns; they are about supporting and benefiting from the growth of the economy at large. It’s this symbiotic relationship between businesses and other asset classes that savvy investors leverage for long-term financial success.