Long term wealth creation in Sri Lanka: How Equities deliver superior returns

K Seeds Investments Director Nimanga Shehan Senanayake

By Nimanga Shehan Senanayake

Long-term asset allocation is ultimately a question of compounding rather than timing. It is rather convenient to assess and display performance in the midst of short-term volatility and market noise, often highlighting very high returns to investors; however, what matters more is long-term performance. As at 31st December 2025, the Colombo Stock Exchange All Share Price Index (ASPI) recorded a five-year compound annual growth rate of approximately 27.28%, which confirms the theory and aligns with the long-established, globally accepted thinking on equity outperformance.

To appreciate the significance of the figure mentioned, we need to contextualize it against realistic alternatives available to Sri Lankan investors. Essentially, a five-year CAGR of 27.28% implies that capital invested at the market level at the end of 2020 more than tripled by the end of 2025. By comparison, fixed income instruments, including T-bills, bonds, and bank fixed deposits delivered annualized returns typically averaging approximately 10% over the recent five-year period, varying based on duration and interest rate cycles. 

Bank fixed deposits, while is the preferred form of investment by most retail individuals, they perform even less favourably in real terms. While nominal deposit rates periodically rose into double digits during monetary tightening cycles, inflation averaged high single digits and, in some periods, exceeded deposit yields altogether. This resulted in compressed or negative real returns for depositors, particularly with the reinvestment risk and tax leakage taken into account. The main things that retail investors do not take into consideration in a growing economy is that unlike equities, deposits do not benefit from earnings growth and dividend reinvestment for example. 

In calendar year 2025 alone, the ASPI gained over 41.89%, following strong gains in 2023 (49.66%) and 2024 (25.5%) as corporate earnings recovered and investor risk appetite normalized. However, it is also important to remember that, annual returns of this magnitude are inherently volatile, and can only be achieved with tactical market timing. 

Equity-oriented unit trusts performance also indicate that diversified equity funds delivered five-year CAGRs exceeding 20% in multiple cases, with some closely tracking or marginally outperforming the ASPI depending on sector allocation and stock selection. Balanced funds, by contrast, consistently underperformed pure equity exposure due to the return drag imposed by their fixed income components. Thus, as expected, while substituting equities with lower-risk assets reduces volatility, it also comes at a cost to long-term returns.

The comparison of equities with real assets also reinforce the same conclusion. Real estate, while often viewed as a long-term store of value by most in Sri Lanka, suffers from structural inefficiencies. For example - transaction costs with brokers and legal fees sometime exceed 8–10%, and liquidity is limited, pricing is opaque, and leverage introduces sensitivity to interest rate cycles. Also, net rental yields, after maintenance and vacancy costs, rarely exceed mid-single digits. So, as an asset class, while property values may appreciate over time, the absence of scalable reinvestment mechanisms and the frictional costs of ownership mean long-term returns ultimately lag behind equities, barring exceptional investments.

Gold too, as a non-productive asset, which generates no income and relies entirely on price appreciation, while it can outperform equities during inflationary spikes or periods of geopolitical stress, as we saw recently, it underperforms productive assets over full market cycles. Comparative asset class data from 1990 to 2025 shows equities outperforming gold by a wide margin, where Global Equities showed a 8.1% average return per annum, with a volatility of 14.7%, as opposed to Gold giving returns of 6.7% average return per annum with a volatility of 15.4%, despite episodic gold rallies sometimes resulting in high returns if tactically timed right, which is however also the case for equities. 

Ultra-long-term datasets compiled by Credit Suisse also show that equities have outperformed bonds by approximately 3-4 percentage points per annum over more than a century and outperformed cash deposits by an even wider margin. 

While Equity market returns/performance in Sri Lanka are more often than not correlated to trends and investor sentiment, the economic explanation for this outperformance is essentially that, equities represents a residual claim of company cash flows. As a country experiences growth, revenues grow, operating leverage improves margins, and retained earnings are reinvested at rates that exceed the cost of capital. These retained earnings compound internally before being reflected in market valuations. However, debt instruments do not participate in this process, as their returns are fixed and are more often than not diluted by inflation and/or currency depreciation. 

Also, Sri Lanka’s equity returns must also be understood in the context of valuation normalization. During the crisis years, equity valuations compressed and there was a drastic decline in the market. As stabilization measures over the past few years took hold and earnings improved, valuations reverted toward historical norms, and then proceeded to move higher too. Similar patterns have been observed in other post-crisis markets globally.

Individuals with limited financial literacy often fail to distinguish between capital preservation and wealth creation, and believe that saving money in a fixed income instrument is an Investment sometimes. It is important to understand that fixed income instruments most definitely do play a role in liquidity management and short-term risk mitigation, but, however, when the objective is wealth accumulation over long time periods, these instruments are incapable of delivering outcomes comparable to asset classes such as equities or other real assets. It is however, also very important to remember that, no asset class outperforms in every year. 

Thus, for an intelligent investor who understands the market, equities offer the best path to long-term wealth, particularly due to being able to invest in preferred sectors with liquidity. If done with discipline and avoiding the short-term hype, equities would most likely outperform other asset classes over time, and provides one of the best avenues to long term wealth creation in Sri Lanka.