Historically return on investment in equity over last 31 years has been higher then fixed deposit by 17.72% (sensex 27.03% vs FD 9.31%). Such out performance following can be attributed to following few rationale.
- Banks are the lifeline of any economy. They have to make profits also. They take deposits and then lend a part of it to the companies at a margin of appx 3- 5%. The companies, in turn, take such loans on the hope of generating higher return than their cost. And since the price of a stock is determined in the long run by the earnings of the company, it can very well be expected that return on equity investment will outpace fixed deposits. Tax rate differential make such outperformance even more attractive.
- Company managements are well aware that the return earned by the equity shareholders over a period has to be higher than the risk free fixed deposits otherwise the stock price might get hammered, affecting the interests of the promoters the most.
- It is always in the interest of any economy that the return on employment and tax generating equity must be higher than the fixed income instruments. It also helps to curb indirectly social unrest and improve the standard of living of the mass.