…is my happy space.
When I’m having a difficult market day,…
…I open my calculator…
My friend clears all doubts in a flash.
It’s easy to compound on the calc.
In German they’d say “Pippifax”.
The younger tribe in the English-speaking world would say easy peasy…
Let me run you through it.
Let’s say you wish to calculate an end amount after 25 years of compounding @ 9 % per annum.
Let z be the initial amount (invested).
The calculation is z * 1.09 ^25.
You don’t have to punch in 25 lines. It’s 1 line.
What if you went wrong on the 18th line?
So 1 line, ok? That’s all.
What’s ^ ?
This symbol stands for “to the power of”.
On your calculator, look for the y to power of x key, and then…
…punch in z * 1.09 (now press y to the power of x)[and then punch in 25].
What does such an exercise do for me?
Meaning, why does this exercise ooze endorphins?
Let’s say I’m investing in sound companies, with zero or very little debt, diligent and shareholder-friendly managements, and into a versatile product profile, looking like existing long into the future, basically meaning that I’m sound on fundamentals.
Let’s say that the stock is down owing to some TDH (TomDicK&Harry) reason, since that’s all it’s taking for a stock to plunge since the beginning of 2018.
I have no control over why this stock is falling.
Because of my small entry quantum strategy, I invest more as this fundamentally sound stock falls.
However, nth re-entry demands some reassurance, and that is given en-masse by the accompanying compounding exercise.
At the back of my mind I know that my money is safe, since fundamentals are crystal clear. At the front-end, Mr. Compounding’s reassurance allows me to pull the trigger.
Let’s run through a one-shot compounding exercise.
How much would a million invested be worth in thirty years, @ 11% per annum compounded.
That’s 1 * 1.11^30 = almost 23 million, that’s a 2300% return in 30 years, or 75%+ per annum non-compounded!
Now let’s say that my stock selection is above average. Let’s assume it is good enough to make 15% per annum compounded, over 30 years.
What’s the million worth now?
1 * 1.15^30 = about 66 million, whoahhh, a 6600% return in 30 years, or 220% per annum non-compounded.
Let’s say I’m really good, perhaps not in the RJ or the WB category, but let’s assume I’m in my own category, calling it the UN category. Let’s further assume that my investment strategy is good enough to yield 20% per annum compounded.
Ya. What’s happened to the million?
1 * 1.20^30 = about 237 million…!! 23700% in 30 years, or 790% per annum non-compounded…
…is out of most ballparks!!!
How can something like this be possible?
It’s called “The Power of Compounding”…,
…most famously so by Mr. Warren Buffett himself.
Try it out!
Pickle your surplus into investment with fundamentally sound strategy.
Lo, and behold.
It’s the nature of the beast.
Stocks also multiply.
For stocks to multiply, one needs to do something.
What is that something?
One needs to buy stocks when they crash.
Let me give you an example.
Let’s assume markets are on a high, and there’s euphoria.
Excel Propionics is cruising at a 1000.
The prevailing euphoria seeps into your brain, and you buy Propionics at a 1000.
For Propionics to multiply 10 times in your lifetime, it will now need to reach 10,000.
Cut to now.
Stocks are crashing.
The same stock, Excel Propionics, now crawls at 450.
You have studied it.
Ratios are good.
Numbers are double-digit.
Leverage is low.
Management is shareholder-friendly.
You start buying at 450.
By the time the crash is through, you have bought many times, and your buying average is 333.
For Propionics to multiply 10 times in your lifetime, it will now need to rise to 3330.
Which event is more likely to happen?
Just answer intuitively.
Of course, the second scenario is more likely to play out than the first one. In the second scenario, Propionics will need to peak 3 times lower.
Try buying in a crash.
You are shaken up.
There’s so much pessimism going around.
Rumours, stories, whatsapps, opinions. The whole world has become an authority on where this market is going to go, and you are dying from inside.
What’s killing you?
The hiding that your existing portfolio is taking, that’s what’s killing you.
Are you liquid?
Why aren’t you liquid?
Create this circumstance for yourself.
Optimally, be liquid for life.
Then, you will look forward to a crash, because that’s when you will use your liquidity copiously, to buy quality stocks, or to improve the buying averages of the already existing quality stocks in your folio.
How do you get liquid for life?
You employ the small entry quantum strategy.
Yes, that’s about right.
We’ve been speaking about this strategy in this space for the last two years.
Easy come, easy go…
…am sure you heard that one before…!
When you come into something too easily, you sure do want to spend it, right?
Well, why not?
However, do take that one step back.
Let’s explore the possibilities here.
You can spend it all. Have a blast. Blow it up. Yeah. We’ve touched upon that. Know many people like that.
Or, you can save some and spend some.
How about that?
Who’s asking you to save it all?
You like spending?
Fine. Spend. A bit. Gratify your most burning desires without injuring anyone’s fundamental rights.
Then, save the rest. Pickle it. Look away. Move on with your life.
Lady Luck smiled. You got your one-off dose of wealth. Use some of it to make wealth a permanent feature in your life.
For that to happen you’ll need to invest, be patient, compound, reinvest and what have you, till many many cash flows take care of all your needs.
From which point did it start?
From the moment you decided to save some of your corpus and provide it with the necessary environment to grow.
It’s a basic decision…
…, yeah, a real simple one…
…that’s tough to implement.
Try retaining wealth.
You’ll then know exactly what I’m talking about.
What’s with this wealth vs income series?
It goes on and on.
Thoughts are like threads.
They can be pulled into infinite.
Also, they are a realm in which one has unlimited freedom.
The speed of thought is faster than the speed of light.
Think about it.
From here to there – anywhere – Jupiter – Uranus – some other universe – in a flash.
Explore your thoughts. Pull them out into infinite threads. It pays.
We are trying to understand the meaning of wealth.
How is it different from income?
What’s the one elephant-in-the-room factor that sums up this difference?
Is there even such a factor?
Yes, I feel there is.
Maybe someone’s come up with this before. I don’t care. We all stand upon the shoulders of giants, as do I. From there, we generate our two pennies.
So, how is wealth intrinsically and basically different from income?
Income is something you take out of your flow, to finance your everyday environment, including shucking up for nitty-gritties in day to day lives of those who depend upon you.
Wealth can be generated from that portion of your flow that has not been taken out for mundane use. This flow, which has not been taken out, has then been simultaneously allowed to coexist by you in a different form, over a long period of time. It accrues, compounds and multiplies – over the long period of time – into wealth.
The most lucrative things in life are also the most simple ones.
Being simple doesn’t come easy to most of us.
That is why the majority of humans are not wealthy.
It’s us too.
We’re all whacky, at some level.
Humans have quirks.
Different ones to make the world go round.
Normal for me would be idiosyncratic elsewhere.
So there we are.
The other day someone was talking about panty-automats and strawberry-excretia. Way off the bell-curve, thought I. What was it about the Japanese?
Then, how were we perceived, as people?
We do have some ugly habits, us Indians.
Ever seen a guy doing an ayurvedic nasal-cleanse on the road? Sure.
Most leave the ayurvedic out.
Occupying someone else’s seat – we’re champions at that.
I’m sure you’ve heard of Indian Standard Time.
Cleaning house and throwing the dirt on the road outside our house – yeah, we’re geniuses.
However, one of our quirks is actually positive.
It’s inborn. In our genes. Adding up. Compounding. All this comes naturally to us.
Yeah, silver lining. Does redeem us a bit, since this particular quality is in short supply, the world over.
Here’s hoping that we infect other nations with the savings bug.
Also, every nation has some positive quirks. Let’s look for these, to adopt.
Everyone’s heard of fixed deposits (FDs).
Are they so non-lucrative?
I believe that in some countries, you need to pay the bank to hold a fixed deposit for you.
Why does our system shun savings?
What are savings, actually?
On-call cash. Ready for you when an opportunity arises.
That’s exactly it. The system doesn’t want you to have ready cash when an opportunity is there.
Because finance people have already dibsed on your cash. They want it when opportunity is there. The cash should be available to their institution, not to you.
That’s why, your bankers generally try and get you to commit whatever spare cash floats in your account. They try for commitment towards non-access for a specific period of time.
I don’t know how things are in other parts of the world, but in India, a fixed deposit is still considered ready cash, because one can nullify one’s FD online, in a few seconds. Some banks charge a penalty for such nullification, but this penalty is charged on the interest generated, not on the principal. Therefore, in India, you have access to at least your FD principal (plus a part of the interest generated) when you really need it, all within a few seconds.
What’s the meta-game here?
You “lock” your money in an FD for one year, for example. Let’s suppose that within that one year, no opportunity arises for you. You cash out with full interest. In India, as of now, if you’re in the top taxation bracket, and are a senior citizen, you’re still left with a return of between 6.6%-6.8% after tax, whereby we are not looking at the effects of inflation here, to keep the example simple, though I know, that we must look at inflation too. We’ll go into inflation some other day.
Meanwhile, your FD has been on call, for you. Let’s assume that a lucrative investment opportunity does arise within the year, and your break your FD after 6 months, reducing earned interest to 4% annualised from 9.5-9.75% p.a. However, your investment yields you 20% after tax, because it was made at the most opportune moment.
You do the math.
Do you see the inherent power of ready money?
Your FD has thus worked for you in multiple ways.
It has worked as an interest-generator, yielding a small return. Simultaneously, it has worked as ready cash, on-call in case of opportunity. Should the opportunity arise, and if the investment that follows works out well, a handsome return could be made. It’s all should/could/would in a meta-game.
There is yet another way FDs are used. I use them this way.
FDs are a safety-net. They allow you to take high risks elsewhere. You lose the fear of high risk once you know that your family is secured through your safety-net. In a safety-net, sums are large enough and deposits are regular enough to discount (actually effectively / realistically nullify) the power of inflation. With the haven of a safety-net going for your family, you can enter high-risk arenas fearlessly. Fearlessness is a perquisite to do well in high-risk arenas. If you’re afraid of loss, don’t enter such areas. Safety-nets make you lose your fear of loss elsewhere.
People – SAVE!
Create FDs. Don’t listen to your bankers. Commit your money to an uncompromisable lock-in only if you’re convinced that the investment is safe and really worth the lock-in for you. Harness the power of the FD for yourself. A safety-net of FDs is the first step towards the formulation of a profitable meta-game.
Did you also know that when you create an FD, the money used to create the FD doesn’t show up as ready cash in your account. Bank accounts with large amounts of ready cash over long periods of time are like red flags which online fraudsters look for. Creation of FDs gives extra online safety to your money.
ONLY you are responsible for your money.
Start looking after it.
Start making it grow.
What comes to mind when one thinks of Switzerland?
– Blood Money – world’s haven for,
– “Neutralness” – has never fought a war in modern times,
– Beauty – it is God’s own country, with its mountains, meadows, valleys, lakes, trails…,
– Discipline – blessed with the works, punctuality, law and order, you name it,
– Technological supremacy – for example their watch-technology, or their advances in heavy mechanical engineering,
– Culinary supremacy – as in their chocolates, or for that matter their herbal know-how, superior quality of their milk, and of course, their cheese,
– Love for their country – the Swiss really look after their country, are loyal to it, and would probably die for it willingly.
Only the first factor has a negative sound.
Well, they do provide a safe-haven. I mean, look at all the other factors. People feel that their money’s safe in a swiss bank. You can’t blame a country for being a safe country.
Most of the world is not safe today. So, most of the world’s money flows to locations that are considered safe. A good percentage of the world’s money is blood money, but that’s how it is. When foreign funds flow into a country, a country doesn’t ask questions. Do we in India ask questions? No. For all we know, it is Mafia money flowing into our country, inflating our markets. Nobody cares as long as it is coming in.
When foreign funds flow into a country excessively, as is the case with Switzerland, such a country can dictate the interest-rate it pays out for such funds. For many, many decades, Swiss banks have been in demand because of the safe-haven quality of their country, and the interest-rate doled out is a pittance, something like 0.5 % or perhaps 1% per annum, something in that range. I could be making a mistake of an odd 1 % here or there, but, you see, people don’t store their money in Switzerland so that it accumulates to an even bigger amount. They store it there so that the principal stays safe. Switzerland doesn’t participate in wars. Thus, wealth is not destroyed. In fact, during wars elsewhere, fund-flow towards safe-havens heightens.
And that’s the game. Almost unlimited inflow, pittance of a payout, loan the money further on 6%, 7%, 8%, huge differential, year upon year, decade upon decade, humungous compounding, enough to spark-off, inculcate and fully support massive all-round development – couple this with all the other factors given above about Switzerland, and you have a hugely positive n-th loop. A hugely positive n-th loop is the exact opposite of a hugely negative vicious cycle. Switzerland sets the framework for the all-round blossoming of life, and the inflow provides lubrication and fuels development. After a while, they don’t depend upon the inflow anymore. In fact, the Swiss were probably self-sufficent even before the inflow began. That’s how they were able to provide a stable system. The inflow is just a bonus. Due to the power of its compounding, all the other diamond qualities of CH sparkle even more brightly.
Living in India, with its legacy of corrupt leaders who have siphoned off most of our wealth towards safe-havens, how should one react?
It is not the fault of the safe-haven. We need to evolve and make our own citizens feel comfortable with keeping their funds here. Our system needs to provide that safety.
Only then will the funds stay here. If our funds are not staying in our own country, it is our own fault.
Not too long a time ago, in an existence nearby, people saved.
Credit was a four letter word, or a six letter word, or whatever you want to all it, as long as you get my point.
People worked hard, and enjoyed the sweet taste of their labour.
They knew their networth on their fingertips, and there was no question of extending oneself beyond.
People were happy. They had time for their families. Words like sophistication, complicated and what have you had simpler meanings.
At the end of the month, as large a chunk as possible was pickled away.
Safety. Steady growth. For building a lifetime’s corpus. For the future generation.
Life was straight-forward.
Then came leverage.
At first, leverage was an idea that was looked down upon. People were slow to leave their safety zones.
Then they saw what leverage could do.
It could make possible a lifetime of fun. One could do things which were well out of one’s financial reach currently. Leverage could even buy out billion dollar companies.
All one had to do was to pledge one’s incoming for many, many years. If that didn’t suffice to fulfill one’s fun-desires, one could even pledge the house. The money borrowed would eventually be paid up, along with the compound interest, right? After all, one had a steady job that promised regular income.
What use was a lifetime of sweat if one didn’t get to enjoy oneself? One couldn’t really live it up after retirement, could one? That’s when one would eventually possess enough free funds to do what one was doing now, with the advent of leverage.
The do-now-pay-later philosophy soon took over the world.
Without being able to afford even a meaningful fraction of their expenditure, people began to go beserk.
What people didn’t know, and what they are now finding out the hard way, is that leverage is a double-edged sword. Since people didn’t know this, and since they didn’t bother to read the fine-print of the documents they were signing while leveraging their monthly salary or their home, well, financiers didn’t bother to educate them any further. No hard feelings, it was just business strategy, nothing personal.
Today, we know more. Much much more. Hopefully we have learnt. We are not going to make the same mistakes again.
So, when you buy into a company, look at the leverage on the balance-sheet. A debt : equity ratio of 1 : 1 is healthy. It promises balanced growth. If the ratio is lower, even better. We’ll talk about debt : equity ratios that are below 0.5 some other day.
Most companies do not have a healthy debt : equity ratio. Promoters like to borrow, and borrow big. You as an investor then need to judge. What exactly is the promotor using these funds for? Is he or she using these funds to finance a hi-fi lifestyle, with flashy cars, villas and company jets? Or is the promoter using these funds for the growth of the company, i.e. for the benefit of the shareholders? Use your common-sense. Look into a company’s management before buying into any company.
As regards your own self, reason it out, people. Save. As long as you can avoid taking that loan, do so. Loaned money comes with lots of hidden fees. If I’m not mistaken, now you’ll even need to pay service tax and education cess on a loan, but please correct me if I’m wrong. There’s definitely a loan-activation fee. Then there’s the huge interest, that compounds very fast. Ask someone who has borrowed on his or her credit card. There’s the collateral you’re promising against the loan. That’s your life you’re putting on the line. All for a bit of leveraged fun? How will your children remember you?
Also, when you invest with no leverage on your own balance-sheet, your mind is relaxed. There is no tension, and your investment decisions are solid. Furthermore, if you’re invested without having borrowed, there’s no question of having an investment terminated prematurely because of a loan-repayment date maturing coupled with one’s inability to pay.
How does the following sentence sound?
” Then came leverage, and common-sense disappeared.”
Not good, right?
Air India and Kingfisher Airlines (KFA) … can you name two things these two have in common?
They’re both loss-making airlines.
Furthermore, there’s lack of will-power to make them profit-making, from the very top.
The problem with a government job is that you can’t kick the government servant out. The government servant thus enjoys complete job-safety and total lack of accountability. That’s been India’s recipe for ineffectivity and loss-making government institutions for decades. In Air India’s case, add to this massive subsidization by the government. Whenever the Maharaja can’t pay his bills, which is like every month, the government of India chips in with tax-payer money. There’s no real policy being pushed through to effectively earn something. Government servants travel free, big-time. If there’s a shortage of seats, honest, real-money paying citizens are off-loaded and left stranded to accommodate the highly evolved souls that rule our country.
Seriously, why do you still travel Air India? Because it’s cheap? Don’t you see through the tomfoolery? Are you blind? They might wake up upon sensing a complete lack of interest amongst travellers. Until that happens, and until they start performing with no ad-hoc cancellations and off-loading, travellers need to give them that wake-up call by using other airlines and by not subscribing to any money-raising gimmicks or IPOs that the company might come out with.
Cut to KFA. What’s wrong with Mr. Mallya? Unpaid pilots, unpaid fuel bills, unpaid taxes, seriously!?!
Vijay Mallya’s story is not about lack of efficiency. It’s about flamboyance. At the cost of his shareholders? Perhaps.
His liquor business is performing well. A little hand-holding through initial turbulence would have seen KFA through. One pays one’s pilots. Period. You don’t just hire scores of great pilots and buy a huge fleet of aircraft, and then stop paying your pilots. Such flamboyance is going to result in a loss-making enterprise for a few years, isn’t that common-sense? In that period, the hand-holding comes into play from the promoter’s other profit-making enterprises, right? Does that seem to have happened here? Unlikely, looking at the current status of KFA’s balance-sheet. Quarterly losses of 100 million USD and growing coupled with a burgeoning debt, Jesus Christ…
The airline industry involves a very precarious vicious-cycle. If you can avoid falling into it from the start, you are through. Prime example is Indigo Airlines.
The first signs of letting up tighten the noose one more notch. Unpaid pilots result in strikes leading to delays and cancellations. A traveller who has been bitten once decides to travel with the competition. Numbers fall. Now, fuel bills can’t be met. More problems, more delays and cancellations. Finally, you can’t pay your taxes. That’s when the tax department steps in. Headlines go ballistic. Huge bad publicity. Twitter battles. What was that? You want the same mollycoddling as Air India? You want government subsidization? Which world do you live in? Not happening!
Money needs to flow into KFA, not loaned money, but clean money, out of the parent-group’s own coffers. Any usage of KFA revenues to fund the parent-group’s activities is a strict no-no. For example, if the Kingfisher Formula 1 team or the group’s IPL Cricket team were even partly funded by KFA revenues, that would be a huge, huge red flag, given the financial condition of KFA. As of now, shareholders need to see some will-power emanating from the top to control the bleeding. The Street can even short the KFA stock down to zero if the promoter’s attitude does not change. Perhaps such an image-beating would be a wake-up call for the promoter.
You’ve started to rake in regular profits on your poker table, or, if you will, on your regular trade-size.
Common-sense now tells you, that you need to scale it up a bit. After all, you’d still be risking the same percentage of your stack-size per trade. Simultaneously, if your win-ratio remains constant, you’d be allowing your stack to grow at a faster pace.
You move on to a higher table.
Welcome to the concept of position-sizing.
Those who position-size can evolve into huge winners in minimum time. Even though the idea of position-sizing is so central to trading, it is still one of the most under-discussed of topics. We need to thank Dr. Van Tharp for teaching this concept properly.
Think about it. When you win, your principal increases. On the next trade, you then put the same principal percentage at risk like you’ve always done. Because your new principal was more, it allowed you to buy more. Thus, you put yourself on the line to win more.
What’s essential here is also to down-size your position when you are losing. Taken a few bad beats in a row? Move down to a lower table for a bit, man. Allow your stack to recuperate at this lower level and then some before moving back higher. With that, when you’re losing, you start to risk less. Crucial point.
Of the different methods available to you to position-size, here, we speak about increasing trade-size when a new trade starts.
The advantage you enjoy when you’re doing pure equity is that on each new trade, your position-size can pinpointedly be adjusted according to your stack-size. Scale-up, scale down, trade upon trade, as the situation demands. Beautiful.
Why does this work out so beautifully for you?
You see, your system gives you an edge. You are opening your positions on high-percentage winners only. Period. Simultaneously, you are cutting your losses at your pre-defined maximum. You are also allowing your winners to win more. And, you are taking your stops. Even if your system then gives you a 55:45 edge over Mrs. Market, you’re doing great. Over a large sample-size (many, many trades, or for that matter many, many poker hands), your stack will increase with a high level of probability. As it goes on increasing, you keep turning on the heat by increasing your position-size further and further.
What happens then? What do you see?
Something beautiful happens.
Your trading principal (what we’ve been calling stack-size all the time) starts to increase exponentially. Have you seen the progress of an exponential function as one travels from zero to the right on the x-axis (the x-axis here would stand for sample-size or the number of trades taken)? If not, check it out on the net.
A good system should give you a 60:40 market-edge. In the Zone, you’d probably trade at 70:30 or beyond. That’s 70 winning trades out of every 100 taken, and 30 losing ones. Imagine what that does to your trading principal over 1000 trades, if you adhere to position-sizing, let your winners ride and take your stop-losses.
The numbers will boggle your mind.
Go for it.
At first, the power of compounding is a slow and steady trickle. Then, it starts gathering momentum. Finally, after a long time, it reaches epic proportions.
If you make the power of compounding work for you from as early an age as possible, you could well achieve financial freedom in your early- to mid- 40s. How does that sound?
Let’s say that your investment gives you a steady 8% per annum compounded. In 25 years, it us up almost 7 fold.
If the investment is giving 12% per annum compounded, in 25 years it will be up 17 fold.
15% per annum compounded – will be up almost 33 fold in 25 years.
20% per annum compounded – 95 fold.
27% (Warren Buffett’s average lifetime return per annum compounded, calculated some years before he donated his fortune to charity) – almost 394 fold.
42% (Rakesh Jhunjhunwala’s average lifetime return per annum compounded, that’s what they say) – 6415 fold.
What do you say to that? Don’t the figures speak for themselves and prove to you the power of compounding? Wouldn’t you like to start harnessing this power from like right now?
Let’s do another exercise. We are now looking at an investment term of 30 years. Other conditions remain the same.
An investment yielding 8% per annum compounded, in 30 years, will be up 10 fold, or a 1000%.
If the investment is giving 12% per annum compounded, in 30 years it will be up almost 30 fold.
15% per annum compounded – will be up 66 fold in 30 years.
20% per annum compounded – up 237 fold in 30 years.
27% – 1300 fold.
42% – 37038 fold.
Don’t the figures just blow you away? (They are so startling, that I have to ask myself if I’ve made some mathematical error. Why don’t you check these figures for me and inform me if there is an error).
The harnessing of this power of compounding is primarily the domain of the long-term investor. Nevertheless, the prudent trader uses it too. Such a trader ties up vast sums of money in fixed income investments for long periods of time, and then just trades on part of the yielded income, using the rest to live well and reinvesting what is still left.
It’s really time you start making use of the power of compounding. If not for yourself, then at least harness it for the futures of your children.
Imagine having lunch with a legendary investor like Warren Buffett. The first think he’ll talk to you about is the power of compounding. And when you say “Huh, what’s that?”, he’ll ask “Did nobody teach you about money management?”
And that’s the whole conundrum. Nobody teaches us how to manage money in school. Nor is this subject taught in college. We are left high and dry to face the big bad world without having the faintest clue about how to make our assets grow into something substantial.
Now why is this so? Is it that parents, teachers and professors worldwide have decided that no, we are, under no circumstances, going to teach our children how to manage their assets. No, that’s not the case. What is far truer is the fact that most parents, teachers and professors don’t know how to manage their own assets in the first place, so there’s no scope of teaching this art to others.
And do you know why that’s sad? Because youth is a prime time to sow seeds of investment that will grow into mountains later. When one is young, time is on one’s side. Salting away pennies at this stage puts into motion the power of compounding, a prime accelerator of growth. The time factor gives one tremendous leverage to deal with meltdowns, crises, calamities, catastrophes, recessions, depressions and what have you. As one grows up, one’s intelligently invested money has a very high chance of coming away unscathed and compounded into a substantial amount.
Don’t take my word for it. Just look around you. If you’ve been invested in the indices in India since 1980, your assets have grown 180 times in 30 years. That’s so huge that one is lost for words. This is despite all issues Indian and world markets have faced in these 30 years. All political crises, all wars, all scams, all corruption, everything. And, these returns are being generated by a simple index strategy. More advanced mid- and small-cap investment strategies have yielded many times more than these returns over this 30 year period. So just forget about meltdowns and crises, invest for the long-term, invest for your children, do it intelligently, and involve them in your investment process. Teach your children how to invest rather than making them cram tables or rut chemical formulae. Get them to take charge of their financial futures. Make them financially independent.
God has given the human being brains, and the power to think rationally. Let’s use these assets while investing. We’re looking for quality managements. We want their human capital to be working for us while we do other things with our time. We want them to figure a way around inflation, so that our investment doesn’t get eaten into by this monster. We don’t want them to involve our money in any scams. We want them to create value for us, year upon year. We want them to pay out regular dividends. Let’s inscribe this into our heads: we are looking for QUALITY MANAGEMENTS.
We are not looking for debt. The company we are investing into needs to be as debt-free as possible. During bad times, and they will come, mountains of debt can make companies go bust. There are many, many companies available for investment with debt to equity ratios which are lesser than 1.0. These are the companies we want to invest into.
We are also looking for a lucrative entry price. Basically, we want to buy debt-free quality scrips, and we want to buy them cheap. For that, we need to possess the virtue of patience. We just can’t get into such investments at any given time, but must learn to patiently wait for them. Also, we must learn to be liquid when such investments become available. Patience and timely liquidity are virtues that more than 99% of investors do not possess.
The central focus while investing is on returns. Over the last 100 years, adjusted for inflation and tax-deductions, fixed deposits have given negative returns. And, over this period of time, the asset class of equity has yielded around 6 % compounded per annum (adjusted for inflation), which is more than 5 times what gold has yielded. There’s human capital behind equity, which strives to give returns despite inflation, and goes around taxes through legal loopholes. Gold is gold, there is no brain behind gold. It cannot evade the forces of inflation and taxation. Thus, equity is a higher yielding asset class. For those who don’t realize the value of a 6% compounded return per annum over the long run after adjusting for inflation, let me give you an example which might boggle your mind. Had the Red Indians who sold Manhattan Island to the Americans in 1626 invested their 60 Gilders (= sale proceeds, with the purchasing power of USD 1000 today) @ 6 % per annum compounded after adjusting for inflation, their principle would have been many times the total value of entire Manhattan today. See? In the world of long-term investing, one needs to be clear about the fact that the power of compounding can move mountains.
At the same time, drawdowns in the asset class equity are also the largest. During the 2008 meltdown, the likes of a Rakesh Jhunjhunwala saw his portfolio shrink by 60%. He took it without blinking, by the way. Why? Because equity is not for the faint-hearted. Steadfast investors know inside out that equity has given these returns despite two world wars, one great depression and many recessions / meltdowns. Today, there’s a crisis, and then there’s another crisis. One’s portfolio gets walloped from crisis to crisis, and needs to survive all crises to get to the good times. A potential USD 184 billion debt default looming in Dubai doesn’t shake the long-term investor. Why not? What if the potential debt default becomes larger, let’s say USD 1 trillion. Still nada. What’s the deal?
When a long-term investor puts money on the line, he’s willing to risk 100% of it. Why? That’s because in such an investor’s portfolio, there’s a whole range of scrips. Some go bust, others don’t do well, some remain at par, and a few outperform. Those scrips that go bust or yield below par have a loss limit of 100% of the principal. And the long-term investor has already termed this loss as acceptable as per the dynamics of his risk-appetite. What’s the outperformance limit on those of his scrips that outperform? None. They can double, triple, multiply even a 100-fold, or a 1000-fold or more over the long-run. 2 examples come to mind, a Wipro multiplying 300,000 times in 25 years and a Cisco Systems multiplying 75,000 times in 15 years. A steadfast long-term investor will strive to pick quality scrips with an edge, and will go into the investment at an opportune moment, such that the chances of these manifold multipliers residing in his portfolio are high. And, if 20% of one’s picks multiply manifold over the long-run, one doesn’t need to bother about even a 100% loss in the other 80% of the scrips. Not that there is going to be that 100% loss in this 80%, because these scrips too have been picked intelligently and at opportune moments.
So, what’s the best opportune moment to pick up a scrip? The aftermath of a crisis, of course. Such a time-period has something for all. Those who like buying at dips can pick up almost anything they like. Those who like buying at all-time highs can pick up the scrips that have been eluding them because these too will dip during a crisis. A crisis is not a crisis for the long-term investor. It is an opportunity.
Investment is the low to medium risk art of conserving capital and protecting it against inflation, such that in the long run, capital appreciates. Speculation is the high risk art of trying to turn a small amount of money into a large amount.
Investment banks upon the power of compounding. It is an amalgamation of human, monetary and product capital, a combination that favours appreciation in the long run, not linear, but exponential appreciation, owing to the power of compounding. The key requirements are intelligence during scrip selection, patience and tolerance to allow multi-baggers to develop and blossom, and common-sense in handling one’s portfolio. Also, one needs to weed one’s portfolio at times, to remove poisonous scrips.
Speculation banks upon the power of leverage. This construct of finance is a double-edged sword. It can compound one’s profits, but also one’s losses. The speculator tries to cut losses and let profits run. This is easier said than done, because it goes against our natural instincts.
In the end, there are both successful and unsuccessful investors and speculators.
The key to deciding what line one should pursue here is a recognition of one’s own risk profile and appetite. What gives one sleepless nights? What is one’s pain threshold? How much loss can one bear without any effect on family life?
Such questions need to be answered before embarking upon either investment or speculation.