Flawed Thinking That is Disastrous For Your Wealth

Quite often we come across investors who display the following mindset relating to their investment planning:

This is the classic case of flawed thinking that is disastrous to one's wealth!!

Investors make wrong choices when they confuse volatility with Risk. Stock markets are volatile but not risky if one has an investment horizon of 15-20 or 30 years. In fact, it is the most suitable vehicle to create huge wealth over such time horizons.

On the other hand, 'Safe' instruments like bank deposits & debt funds are the best choice for wealth preservation over 1-3 years horizon but extremely unsuitable for wealth creation due to taxation & inflation.

The correct plan for the above investor is:

Wealth Creation Lesson From the Sun

The Sun is the source of all life on the planet. It dutifully rises everyday, without fail to break the night into dawn. Fog. haze, or cloud cover may subdue its light and energy on some days. Yet, it rises with the same intensity and persists in its endeavors. Eventually the clouds clear out, the fog subsides and the haze gives way for its light to shine brighter than ever.

But, what would happen if the Sun were to lose hope due to these 'disturbances' and decide to stop rising?

Creating wealth through Systematic Investment Plan (SIP) requires persistence like the sun to push beyond the haze, clouds and fog!! There would be days, weeks or at times even months of "thick cloud cover" when the markets are in panic mode, owing to whatsoever reason.

Yet, if one fearlessly endures the days of "Thick cloud cover" and continues with the SIP month on month for years continuously, their wealth grows beyond imagination.

Let's rewind and go back 20 years to January 1996 and relive the experience of an investor who would have started their SIP in a diversified Mutual Fund in that month.

Since then, the stock markets have seen some major prolonged 'cloud covers' which must have tempted the investors to  discontinue their SIP in a Mutual Fund.

• Year 1997-98: Asian Financial crisis - Starting from Thailand and spreading soon to Malaysia, Phillipines, Indonesia, South Korea, Hong Kong, China and many others. 
• The BSE Sensex fell 33% - from 4,320 in Aug. 1997 to 2,860 in Sept. 1998
• Year 2000-2001: Dotcom bubble crash; Ketan Parekh Scam, Twin Tower Attack
• BSE Sensex crashes 48% - from 5,465 in March 2000 to 2,820 in Oct. 2001
• Year 2008-09: Global Financial Crisis
• BSE Sensex crashes 62% - From 21,200 in Jan. 2008 to 8,050 in March 2009

And then there is that short-term fog which hits the markets from time to time:

• Kargill war
• Russia attacking Ukraine
• Indian Current Account Crisis of 2013
• North Korea Hydrogen Bomb
• Chinese slowdown

What would be the result of persisting through these long term cloud covers and short term foggy days?

Look at the results below: (Assuming a monthly SIP of Rs. 5,000 started on 1-Jan-1996 for 20 years)

Total Amount Invested over 20 years: Rs. 12,00,000

SCHEME NAME	Approx. accumulated Value as on 1-Jan-2016	Compounded Annual Return (CAGR)
Birla SL Balanced 95 Fund	Rs. 1.40 Crores	20.9% p.a.
HDFC Equity Fund	Rs. 2.06 Crores	24.0% p.a.
Reliance Growth Fund	Rs. 2.47 Crores	25.5% p.a.

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Where should you FOCUS?

Where should YOU Focus?

• Dow, S&P off to worst 4-day Jan start ever as China fears grow
• Soros sees 2008-like crisis 

China on boil: Should India be worried?

The above is just a sample of ever so pervasive news headlines which shout for your attention everytime there is a 'significant' event. 

But should you - as a long-term investor - pay attention? 

Should you rather not be paying more attention on how to ensure that your children get the best education or how your retirement can be planned?

This is where FOCUS comes in.

Consider this:

Exactly this day seven years ago,  that is on 7th Jan 2009, Satyam Computer Services scandal was revealed by its chairman. 

The new York Stock exchange halted the trading of Satyam Computer shares.

Satyam shares crashed from 544 and fell to 11.5 per share.

Indian stock market fell by 749 points on 7th March 2009.

Sensex on 7th Jan 09=9587 points 

Sensex today, 7th Jan 2016=24851.

Returns delivered = 14.58% every year.

Moral of the story.

Do not concentrate on the noise happening in the market.
Instead focus on your financial goals. Noise will continue everyday.

Personal Finance Lesson from Hare & Tortoise story

We have all understood from the traditional Hare & Tortoise Story how 'Slow & Steady Wins the Race'!!

Well, this is true even for personal finance.

How may times you have heard a colleague or a friend or a relative boast of making 50-100% returns on a stock in 4 months? Now, the same friend or relative or colleague would not tell you what he lost on his other bets in his quest to earn some quick money. And, if you happen to speak to him a few months later about the experiences from his stock picking, he would definitely be far less enthusiastic.

This happens because the stock markets are the worst place to consistently make a quick buck.  (Notice the emphasis on 'Consistently') In fact, almost everyone trying to get rich quick in the stock market ultimately comes out brutally scratched & injured - and then blames the stock market!!

He is the proverbial Hare in the story - Excited & Active, Misplaced confidence in his abilities to beat the system consistently.

Compare the above behaviour with someone who follows the most boring & unimaginative but consistent strategy of investing regularly through a Systematic Investment Plan (SIP) over 10 - 15 or 20 years. Look at the following chart (Assumption: Rs. 3,000 invested per month):

This is the result achieved by the proverbial 'Tortoise' in the traditional story!!

Moral: The longer the race, the more startling the margin of victory for the Tortoise.

For useful insights into Personal Finance, visit the Learning Centre at www.deepamfinvest.com

Learning this tool alone can save investors Lakhs!

A major reason that investors get misled into putting their hard earned money into wrong types of plans is their quest for:

High Returns - GUARANTEED

Big financial institutions - (Namely Banks & Insurance Companies) know this mindset of the average investor. They collude & offer you Guaranteed plans weaving such dreams in their sales pitch that it is easy for a gullible investor to fall prey to them.

Recently, a 41 year old businessman friend of mine was approached by his banker with following scheme from a large insurance company claiming a Return on Investment of 8% p.a. GUARANTEED, Tax-Free and FREE Insurance:

• Invest Rs. 10 lakh per year for 10 years in a Guaranteed Insurance Plan.
• You will get a Life Cover of Rs. 1 crore.
• From Year 21 to Year 34, you will get a Guaranteed Payout of Rs. 5,06,380
• At end of year 34, you will get a Guaranteed maturity of Rs. 3,94,62,300

As an incentive to buy this scheme, the banker also offered to reduce the interest rates on my friend's CC Limits!!

This friend, who is a successful business person & brilliant in his work, could not understand what the plan meant but was suspicious of the fact that if the plan was actually so good, why would the banker offer incentives for investing in the plan! He sought my advice.

The best approach in such cases it to use the XIRR calculation in MS Excel. XIRR gives the return % p.a, for a series of known cash flows.

Using the XIRR calculation in MS Excel, one can easily see that the actual return being guaranteed is only 5.47% p.a. (The actual yearly investment would be Rs. 10,30,900 for 1st year & Rs. 10,15,450 for year 2 to year 10)

On careful reading of the brochure given by the banker,it was clear that even this 5.47% p.a. was not guaranteed!!

It is strongly recommended to be familiar with XIRR Function to ward off such fraudulent bankers who are chasing their own bonuses rather than their clients' interest!

For a demo, click http://www.deepamfinvest.com/deepam-learning-centre/irr

Absolute amounts can be misleading

A few years back, my client (around 51 years age) walked into my office along with his 26 year old daughter who had recently secured a job at a prestigious MNC. Both father & daughter were understandably very happy.

However, I learnt that there was another reason for their happiness! My client excitedly informed me that he has just finalised a long-term investment for his daughter which is probably the best investment he has ever come across. Before I could congratulate him, he pulled out a sheet of paper with the following matter hand-written on it:

• Age: 26 years
• Payment Term: 35 years
• Annual Premium: Rs. 13,225
• Life Insurance: Rs. 5,00,000
• Cumulative amount at end of payment term: Rs. 23,45,000
• Annual Pension: Rs. 1,77,165

His excitement about the plan came from the fact that an yearly investment of only Rs. 13,225 would give his daughter an assured pension of Rs. 1,77,000 throughout her life after she crosses 60 years age.

Seems lucrative right? 

An yearly investment of only Rs. 13,225 leading to an assured pension of Rs. 1,77,000 throughout life after crossing 60 years of age!!

If you should use the IRR calculation demonstrated in the video below for any such guaranteed returns proposal, you might be surprised to find that the annualised return of this “lucrative” plan is a measly 7.8% p.a.!

Often, the investors get swayed by the absolute amounts without understanding the time value of money. It is always advisable to use the IRR calculation for any such Guaranteed returns plan.

What can 14% p.a. returns do!!

What can 14% returns do? 

Let us see...

In 1971, Govt’s Enemy Property Office had shares worth Rs. 29 Crores value, mostly belonging to people who left India during Indo Pak war of 1965. In the year 2015 i.e. 44 years later, the shares were valued at 10,000 Cr. 

That is approximately 345 times in 45 years!

Can you imagine what return per year it must have taken to grow by 345 times? 

Approximately 14%, that is all.  

Over 44 years that 14% made 29 Crs turn into 10,000 Crores !!  This was a static investment on which nothing was done,  This 14% p.a. returns is not counting the Dividends that would have been paid out on these shares. 

This is what equities can do over long periods of time, create real wealth. !! Holding for 20 or 30 years can create wealth; buying and selling every 1- 2 years will create lots of paper work and not wealth !!

Moral of the story: 

Invest for really long periods to create wealth

Source for the news on Enemy Property:

http://www.business-standard.com/article/markets/enemy-shares-to-be-dematerialised-115041700037_1.html