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

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Archive for the ‘Basics’ Category

Buffett Fifty: Advice to Investors

Posted by Muthu on March 2, 2015

It is 50 years since Buffett has taken over and running Berkshire Hathaway. In last 5 decades, he has generated an absolute return of 18,26,613%. Yes, you read it right. That works out to an annualised return of 21.6%. During the same period, the index, S&P 500 has given an annualised return of 9.9%. So Buffett has outperformed the index by 11.7%.

Here is a small illustration for you to understand what 21.6% can mean to you for next 50 years. If only a fund can deliver similar return for next 50 years, Rs.1 crore invested today would become Rs.17,647 crores in next 50 years. Lucky are those who trusted and invested with Buffett.

Buffett has released his 50th annual letter on Saturday. Please click here to read the same. The entire 43 page letter is a treasure to read and re-read. I’ve given below a small portion from the same which you may find it insightful.

He explains how during 1964 to 2014, while the markets (S&P 500) appreciated by 11,196%; the currency (purchasing power of dollar) depreciated by 87%. He further explains as to why we should own diversified collection of businesses instead of currency denominated bonds for the long run. Please read on:

“The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities- treasuries, for example- whose values have been tied to American currency. That was also true in preceding half-century, a period including the Great Depression and two world wars. Investor should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments- far riskier investments- than widely diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong. Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing power terms) than leaving funds in cash equivalents. That is relevant to certain investors- say, investment banks- whose viability can be threatened by decline in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near term needs for funds should keep appropriate sums in treasuries or insured bank deposits.

For the great majority of investors, however, who can and should invest with a multi decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing life time. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar based securities.

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned the failing stock prices and advised investing in “safe” treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement (The S&P 500 was then below 700; now it is about 2100). If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund, fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in the markets. And no advisor, economist, or TV commentator- and definitely not Charlie nor I- can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

The commission of the investments sins listed above is not limited to “the little guy.” Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high fee managers. And that is a fool’s game.

There are a few investment managers, of course, who are very good- though in the short run, it’s difficult to determine whether a great record is due to luck or talent. Most advisors, however, are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to their siren songs, investors- large and small- should instead read Jack Bogle’s The Little Book of Common Sense Investing.

Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shakespeare: “The fault, dear Brutus, is not in our stars, but in ourselves.” “

Posted in Basics, Warren Buffett, Wealth | Tagged: , | Leave a Comment »

Dalbar & Performance gap

Posted by Muthu on February 21, 2015

You may know Peter Lynch, one of the best mutual fund managers who managed Fidelity Magellan Fund and produced an outstanding performance. He once said that more than 50% of the investors in his fund lost money despite the fund being an outstanding performer. Reason? Inflows were more after few good quarters and outflows were more after few bad quarters.

Boston based Dalbar releases a QAIB (Quantitative Analysis of Investor Behavior) report every year. Dalbar compares how much the investment gave versus how much the investors made. The difference is called performance gap. From 1984 to 2014, for a period of 30 years, the S&P 500 has given an annualised return of 11.11%. Whereas equity fund investors earned only average annual return of 3.69%. The performance gap is 7.42%.

Why performance gap? When a fund, after expenses, over a 10 year period, gives 18% returns, the investors also should have also made the same. But this rarely happens in a real life scenario. Investors invest more when the markets are high and redeem more when the markets are low. Added to that they keep chasing performance. A good fund is ditched because it had a bad year. A risky fund or not so good fund but which shows recent good performance gets lot of inflow. All these ensure that investors as a group earn less than what the funds provide. In many cases, people actually lose despite markets and funds doing well over a period.

Prashant Jain, one of the best fund managers in the country, in a recent interview has mentioned that only 2% of the AUM in HDFC Equity Fund is more than 10 years old. Since we do not know what percentage (it can be say 0.2% or 20%) of investors hold this 2%, for ease of understanding let me assume that 2% of the investors hold this 2% AUM. So the benefit of long term compounding and superior performance of HDFC Equity Fund is experienced only by 2% of its investors!

I also take this 2% as a representative sample for all equity funds of HDFC mutual fund.

One of their funds, an ELSS scheme, HDFC Tax Saver has given an annualized return of around 28% over last 19 years.

This means that the invested amount has multiplied by 101 times over last 19 years period.

Rs.1 lakh invested in 1996 would have been worth Rs 1.01 crores at the end of 2014.

All sounds good. But if you look at who benefited by these returns; it is only 2% of the investors.

As Dalbar studies has repeatedly pointed out, investor returns is much lesser than the investment returns.

This is because investors are not disciplined. They fear volatility. They do not have patience. They lack long term orientation.

In my last piece, I mentioned that you are one of 4% of the population who have been blessed with the ability to invest. Also you are one of the 1% who has understood the opportunities available and is investing in equity. Most important is you’re one of the rare 0.2% of the country, who has understood the power of investing regularly through SIPs.

Now you would have understood why only few get rich from stock markets or equity investing despite so much of good performance made available by quality stocks, good equity funds and even index itself.

The steps to get rich are easy. But self mastery is extremely difficult. Discipline, patience and long term orientation are the key to self mastery in investments.

As an advisor, I’ve taken it on myself to ensure that you practice this self mastery. I would always stand by you and support you toward this.

In my professional life, I’ve a big ambition. I want hundreds of families to make huge wealth through equity investing by practicing this self mastery. By huge wealth I mean, tens of crores in many cases and 100+ crores in at least few cases.

Already many of you have been doing SIP for last many years. You’ve started seeing the results. You would be amazed to see how much you would be worth in next 10 to 20 years, if you continue in this path.

Stay the course.

Posted in Basics, Mutual Funds, SIP, Stock Market, Wealth | Tagged: , | 10 Comments »

A question and my answer

Posted by Muthu on February 6, 2015

As you are aware, I’ve been contributing to ‘Nanyam Vikatan’ Q&A section for the last 8 years.

In the latest issue, one gentleman asked me the below question.

“I’m 48 years old. I want to start saving for my retirement which is another 10 years away. I can save Rs.10,000 a month for next 10 years and I need a corpus of Rs.75 lakhs at the time of retirement. Please guide me as to how I can reach this goal of Rs.75 lakhs.”

My answer to him was as follows:

“To build wealth, you need to invest in equity. The best way to do is through SIPs in diversified equity funds. If you do a SIP of 10K per month for next 120 months (10 years), at 18% annualised return, you would be able to accumulate a corpus of only Rs.33 lakhsIf you want Rs.75 lakhs in 10 years, you need to save Rs.22,300 every month.

If you can only save 10K per month, then you need to invest for 14 years to get a corpus of Rs.75 lakhs.

So you need to either increase the SIP amount or the investment tenure to achieve the retirement goal of Rs.75 lakhs.”

If you notice, by extending the investment tenure by 4 years, he is able to get 2.3 times more than what he would have accumulated in 10 years and achieve his goal. Whereas if he is particular that the corpus has to be achieved in 10 years, he needs to save 120% more than what he is capable of saving now.

In this case, he should find a way to work for 4 years after his retirement from the current job. Otherwise, even by his own calculations, it would be difficult to lead his post retirement life.

If he had started early, say even at the age of 38, the same 10K invested per month would give him Rs.2.34 crores at the retirement age. He can lead a post retirement life beyond his expectation.

People want substitute for time in investment. Compounding needs time to work and it is always back loaded (i.e.) major portion of wealth gets build up only in the later part of investing tenure.

Searching for higher returns in order to reduce the time required to build wealth may lead to taking unnecessary risks.

If someone is 30 years now and wants to retire at 60 with Rs.100 crores, at 18% annualised return, all he has to do is to save 70K per month.

If you think, Rs.100 crore would be small in 30 years, you are wrong. At 6% inflation, it is worth Rs.17 crores today. In other words, what Rs.17 crores can buy today, Rs.100 crores can buy the same thing 30 years down the line.

Time can compound even small amounts into big sum over a long period of time. If you are saving big amount, then imagine how much it would be worth if only you can give not less than 10 to 20 years for investment to work.

Posted in Basics, General, Media, SIP, Wealth | 18 Comments »

Seven habits of successful investors

Posted by Muthu on January 22, 2015

There are many habits which makes one a successful investor. Since ‘7 habits’ is popular; I’ve chosen below what I consider as top seven habits required for you to be successful in investing. Follow these seven and reach the financial heaven!

1) Start early

2) Invest regularly

3) Think long term

4) Have patience

5) Ignore volatility

6) Ignore non-stop noise from media

7) Stay the course

Posted in Basics, General, Muthu's Musings | Tagged: , | 3 Comments »

Choose Wisely

Posted by Muthu on December 27, 2014

Morgan Housel mentions the below 2 points in this wonderful piece:

“1) Remember what Wharton professor Jeremy Siegel says: “You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds [after inflation]. So which is the riskier asset?”

2) In finance textbooks, “risk” is defined as short-term volatility. In the real world, risk is earning low returns, which is often caused by trying to avoid short-term volatility. ”

As you are aware, for last few years, every April, we publish a comparative chart of performance of various asset classes from 1979-80 to till date.

Between 1979-80 to 2013-14; for the last 35 years; fixed deposits have produced an annualised return of 8.41% and Sensex 16.72% (18.72%, assuming a dividend yield of 2%).

Let us assume, 35 years ago, you invested Rs.1 lakh each in FD & Sensex. As on March 31’st 2014, FD is worth Rs.16.94 lakhs and Sensex is worth Rs.2.23 crores.

Before we feel happy about the above returns, we’ve to understand that the average inflation rate for the above period is 7.57%.

Real rate of return = Nominal returns – Inflation

So the real rate of return for FD is meagre 0.84% and for Sensex is 9.15% (around 11% including dividend yield).

So your investment of Rs.1 lakh in both FD and Sensex, 35 years ago, after adjusting for inflation, is ‘really’ worth as follows: FD- Rs.1.07 lakhs and Sensex- Rs.14.20 lakhs.

Since FDs are taxed every year on accruals, you would not have even got the real return of 0.84% and would be sitting on a negative return. Your Rs.1 lakh investment would be even lesser than the capital value. Whereas Sensex, even after inflation, has multiplied your wealth by 14 times. There is no tax on long term capital gain.

Though it looks FD has multiplied your wealth by 17 times, in terms of purchasing power, it has actually eroded your capital.

Even Sensex, though it appears to have multiplied your wealth by 223 times, has actually done so ‘only’ by 14 times, if you take purchasing power into account.

Many people, especially with real estate and gold, have no clue about annualised return, inflation adjusted return, impact of transactional cost and taxes etc. What we think as what we are earning and what we are actually earning are not one and the same.

The real risk is not the short term volatility you see the in stock markets. The real risk is capital erosion, due to returns eaten away by inflation and taxes. So for all long term requirements, you need to invest in instruments which beat the inflation handsomely and are also tax efficient.

In the above example, equities have beaten inflation by around 9% and also given that return absolutely tax free. What more one can ask for?

So please understand that risk is not short term volatility but long term erosion of capital.

Fixed deposits are not volatile but they erode capital and reduce your purchasing power. Equities are volatile but they multiply capital and increase your purchasing power.

Choose wisely for long run.

Posted in Basics, Muthu's Musings, Stock Market, Wealth | Tagged: , , | 1 Comment »