Updated: Aug 27, 2020
Greetings Investor School family, we’re elated to present our first newsletter. With obligatory salutations completed accept our anticipatory apologies as the first one is a tad bit long. We wanted to start our journey by laying a strong foundation for you, therefore, the ten commandments of the investment world. Quick note: Investment is when you segregate a part of your income and expect it to grow in value in the near- future. We promised to simplify the economic jargon for you and thus these commandments are divided logically into two parts; the ones that you can’t control and the ones you can. For this week we seek to dive into the principles that are more or less out of our control. How does it help then? Well, you can’t control traffic either, but understanding it would nearly negate your probability of being run over. These commandments would help you make informed choices to make sure that you maintain optimum and sustainable growth. Let us begin! 1. Investment is a marathon, not a sprint Long Term Perspective We’re sure that you’re familiar with the lofty claims of your friend of having doubled his investment last month. So, let’s analyze, that’s a 100% return and is suggestive for you to follow suit. There certainly was no mention of numerous attempts and most probably hefty losses. Ego boost and scam alert! The crux of this analysis lies in understanding the difference between Sachin Tendulkar and Shahid Afridi and to drive home the point that developing a reliable technique is a long term process and ‘fluke’ would never match it. Investment is a marathon, not a sprint, and developing a long term vision is an indispensable requirement of this domain. Let’s deliberate on this to consolidate:
2. Eat a balanced meal for a healthy body- Risk diversification Do you realize that your portfolio and your dinner plate are comparable; for argument sake at least? We (Indians) are both famous and notorious for fancying a myriad of flavors, we love to have a bite of each pie. Likewise, a well-diversified investment portfolio is what’s needed and it helps you diversify your risk. Portfolio diversification is distributing your investments across asset classes and time. It makes sure that you do not have all your eggs in one basket. The risk of losing your eggs all at once is eradicated by design. Like chefs, investors have various ingredients to juggle at once - equity shares, bonds, mutual funds, cash instruments, commodities, precious metals, and derivatives. (Diversification across assets). Based on your risk appetite, decide how much proportion of your investments is allocated to each asset class. There is a correlation between assets, two assets can be positively (move in the same direction) and negatively related (move opposite to each other). They can also be unrelated. For minimum risk, you have to choose negatively correlated or unrelated assets. For example, Bond and Equity Markets generally move in opposite directions. Markets generally move in opposite directions, so if your portfolio is diversified across both areas, the loss in one is compensated by the gain in others. Usually, when the stock market plunges, demands for bonds rise thereby incrementing the bond prices. Similarly, equities can be combined with gold in the portfolio. Turbulence in the equity market makes the investors rush for gold. Even within each asset class, diversify across various types of instruments, e.g., in case of stocks, spread out among small-cap, mid-cap, and large-cap. Also, investors need to add to their investments on a regular basis. And so is the return sequence which is often lumpy. (Diversification across Time) Imagine, you and your date went out for dinner and ordered an appetizer, main course, and deserts at once. And all three appeared on your table simultaneously. Talk about lumpy!! Broaden your horizon and enjoy an enriching supper (we mean investing experience)! 3. Don’t forget the mighty inflation You have probably heard the notion that Rs 100 today is more valuable than Rs 100 a year later. The reason being mighty inflation which ensures that you have to eke out additional money the next year. Note: The numbers suggest that the CPI (Consumer price index) inflation in July 2020 was 6.93% as per MoSPI (Ministry of Statistics and Programme Implementation). What is the trickle-down effect of this to the money you put in your good old fixed deposits or cash shoved at home? Here’s the explanation: Imagine you put down Rs 1 lac in a fixed deposit in your bank account for one year at a rate of 7%. It’s a mythical scenario but for the sake of depicting our banks in good light let us assume the same. You happily get Rs 1.07 lacs at the end of the year, but when you go to the market to buy something you realize that everything seems more expensive. You wonder if your money grew at 7%. What happened was that the bike you were planning to buy for Rs 1 lac a year ago is now worth Rs 1.07 lacs. Why? Because the mighty inflation kicked in. So, the effective return on your investment turns out to be almost 0%. In justification, Milton Freidman (Nobel Laureate) was very right to say that- “Inflation is one form of taxation that can be imposed without legislation.” And all of us end up paying it if we don’t understand its eroding impact on our wealth. So, the next time you put money under the bed, just cast a spell to double it overnight! Just kidding! 4. I know how to swim but so does Michael Phelps - Personal Risk assessment We know you are itching to jump into that pool or dive into the sea but unfortunately, its COVID season and the only thing we can offer right is this illustration to help you visualize. Every individual will immerse themselves into swimming or for that matter any activity based on their skill, their appetite for adventure, or based on their cushion because of those cute little floaters on their arms. Analogous to this is every individual’s capacity for risk or risk appetite based on their personal confidence or because of their financial position. In the world of investments, our risk appetite is driven by our ability to tolerate risk or quite simply put how much financial risk can you bear in order to generate returns on your investment. Every investment instrument whether equities, gold, real estate including the FD (Fixed deposits) or so-called safe havens also carry a certain degree of risk. Yes, you heard that right, your fixed deposits or safe deposit schemes also carry risk, and you were never told about it. Note: Fixed deposits and low return investments have the risk of eroding the value of your investment if they are not able to beat inflation. We told you don’t forget the mighty inflation. So, the most important principle for someone beginning or at a nascent stage of venturing into the investment world is to measure how good a swimmer they are (Risk tolerance). Do you want to know which water body is suitable for you? Take a risk analyzer or risk assessment questionnaire to find out your risk tolerance. Once you determine your risk tolerance, it is advisable to allocate your funds appropriately to a suitable investment strategy to meet your financial goals. Last but not the least, next time you go for a beach vacation please tag us along! 5. The power of Compounding Do you remember the time when you questioned whether anything, I study in school will actually be used in real life? Well, I am still figuring out a way to integrate the words to create a differential effect in your life. Just kidding! We actually thought why not make use of something to benefit us in real life, a very simple formula we studied back in class 6th mathematics, it looks like this: A= P (1+ r/n)^nt Look familiar? It’s the simple formula for computing not so simple compound interest. And just to show how important this is we will borrow the words of Albert curly hair Einstein- “Compound interest is the 8th wonder of the world. He who understands it earns it, he who doesn’t pay it.” I am sure you smart folks want to be in the former category. So, let us explain how to take advantage of compound interest, or simply put earn interest on your interest.
Use Time to your advantage: If you are currently under 35 years old, you have the opportunity to extend your investments over a longer period of time
Remember the history lessons: It has been time and time-proven with data that even small investments started at an early age will amount to far greater wealth accumulation than large sums of money invested in the latter half of our lives.
Take the case of our friendly neighborhood Mr. Kalra and Mr. Gupta (refer info-graph)
That’s all Folks! Next week we bring you the five commandments for internal control. Until then... Stick around, stay safe, and spread the word (read IM) to your friends, family, colleagues, and literally everyone.