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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Easy Money

Posted by Muthu on May 22, 2011

We always chase prices and never worry about the underlying asset. 

For the last few months – the focus is on silver. We get excited when there is a significant price movement.

Silver is selling today at around $35 per ounce.

As with any asset bubble, people are forecasting much higher levels in the months to come.

Do you know that in 1980 silver was selling at around $50 per ounce only to fall to $10 in 1981? A fall of 80% in one year.

A price of $50 per ounce 31 years ago would be much higher if we calculate in today’s prices.

Firstly, we don’t read history. Even if we read, as Warren Buffett says that what we learn from history is that people don’t learn from history.

The silver price today in India is around Rs.53,000 per kg. On 1’st of this month, it was Rs.71,576 per kg. A fall of 26% in the last 3 weeks. I hear from my friends in broking industry that many investors lost heavily by betting at the peak for the prices to touch to Rs.1 lakh per kg before end of this month. Since they leveraged their positions, they have to book heavy losses.

Interestingly, the same silver was selling around Rs.20,000 per kg in 2008. It did not evince any interest then!

Famous social networking site, LinkedIn has made its debut in (U.S.) stock exchange. This company which has a bottom line of $15.4 million is valued at around $9 billion.

The PE multiple of this share is more than 550 times. This means that an investor is willing to pay 550 years of current earnings to obtain shares of LinkedIn. I understand that the average PE multiple for technology companies in U.S. is around 15 to 20 times.

Unless LinkedIn grows exponentially in the years to come, it is very difficult to justify or sustain these kinds of valuation.

Remember the price at which you acquire a share is important, even if the company is a good company. You need not go anywhere. Talk to people who invested in our software companies at the height of tech boom in 1999-2000. These companies may be good, but the price they paid was so huge that their returns would not be worth speaking about, even after 10 years.

Even take the case of 2008 stock market peak. Though lump sum investment made in mutual funds at the peak are showing positive returns, sectors like real estate companies have seen the value eroded by 70% now from its peak 3 ½ years ago. One leading telecom company is selling at around 10% of what it is worth in January’08. A loss of 90% even though markets have pulled back.

I’ve been doing analysis on data points available in public domain. It confirms our view that for equity investments the outlook should not be less than 10 years. Even then there is a catch. Looking at rolling average returns, if you invest lump sum at the peaks of the market, the 10 year return is not that attractive, though you would have made some returns.

Lump sum investment fetches excellent returns in long run only if you’ve invested when valuations are relatively attractive.

The whole industry encourages you to invest lump sum investments only during bull markets. We cannot blame only the industry for this. We as investors do not get attracted by an asset when the price is less. Only when the price is going up fast, we don’t want to miss the party and willing to throw everything behind the asset. Most of us invest at peak and wait for years the market to reach back the same levels.

If you want to invest in lump sum in equities – either through stocks or mutual funds, invest only in bear or flat markets – i.e. when valuations are attractive or reasonable.

I’ve seen many people entering and exiting at various level in bull market only to be caught entering again in the peak. Easy money is highly addictive. Since the general direction of many stocks in a bull market is on a positive territory, money made in multiple trades is usually lost in couple of trades made in the last leg of bull market.

Markets seduce you with easy money. Only lucky few get away with that. The rest all contribute from our pockets to those lucky few.

That is why we always advice you to invest regularly and invest for long term, irrespective of market cycles. For long term regular investing, it is better to simply ignore market condition – bull or bear market.

Make lump sum investments only when the valuations are attractive and reasonable. Do not forget this statement in the frenzy of bull market. We made some lump sum investments for our family in equity funds last week as I feel that the current valuations are attractive. I never try to predict the top or bottom, which is impossible.

Again when I say equities would reward you well if you invest regularly and for long term, it cannot be generalized to any economy. For example, Japanese economy and markets have gone no where in the last 2 decades.

Stock market – which is nothing but thousands of companies – cannot do well unless the overall economy does well.

With the Indian economy growth rate expected to touch double digit returns, the corporate sector is expected to do very well.

Assuming a 9% growth rate and 6% inflation, the nominal growth rate works out to 15% p.a. Your income, expenses.. everything is counted only in nominal terms. So if the over all economy grows @ 15%, the corporate sector is expected to do much better. When we make a forward looking statement, we assume only what the Sensex has returned in the last 3 decades – around 18% annualized returns- though good actively managed funds have provided a superior return from the time of their inception.

In our opinion, for next two decades or more, Indian equities would provide superior return to any other asset class. Invest regularly and map the same to your long term goals. Never stop your regular long term investing irrespective of market cycle.

As mentioned above, please avoid lump sum investments in bull markets. If you want to commit lump sum in equities, even for long term, do it only when valuations are relatively attractive.

Since it is nearly 3 ½ years markets have touched its peak, we may expect another bull run in next couple of years. I only hope you remember this piece of writing during next bull run.

We believe in right positioning of a product even if it means loosing customers with a short term perspective. Even a predominantly debt oriented product like MIP is positioned by us for a tenure of 5 years so that the impact of interest rate cycle is well captured.

When we think making money out of the money, in reality money is not made out of the money. It is not possible. Money is made because you participate in a productive activity. Even our fixed deposit earns interest for us because the money is used by an entrepreneur or farmer for a productive purpose. If a bank cannot lend money for a productive purpose, then they would not be able to provide you interest. Then you would end up paying money to bank for keeping your money safely.

In stock market too, the money grows because the companies grow, their sales and profit grow. What we consider as making money out of money is not possible, if the asset we’ve invested does not produce anything.

As a rule, a society can consume only what it is able to produce. Individuals may be an exception to this but as a nation or economy or society, there is no exception to this rule. Money derives value only based on underlying productive asset. Otherwise it is only a paper.

Speculators and traders are the really the ones who try making money out of money. Some succeed and many fail. They do not produce anything and what they play is a zero sum game. Lucky 2% takes the money from the pockets of remaining 98%. This game interested me once. I’m glad that I stumbled upon Warren Buffett a decade ago which changed my focus and also learnt to take advantage of such games people play.

We happen to be in a right economy at a right time. Since we happened to be here, let us use this opportunity for long term wealth building.

For short term or easy money, either we should have inheritance or marry someone who is rich or pursue the high risk, zero sum, non value added way of a trader or probably try becoming a corrupt politician or a high profile guru who owns an island in pacific, travel by business class and use a Land Rover even for covering a distance of 200 metres.

For majority of us, contributing to the economy through our work, skills, knowledge and capital (savings / investments)  is the way for making money.

See the climax of the movie ‘Wall Street’ where a blue collar worker father talks about the essence of money making to a manipulative trader son. That says it all.

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