The overall interest in investing in stock market is back with full swing. Almost everybody is talking about bonds, IPOs, real estate as if they have been invented recently. Having said that, I love the passion behind it when they talk about it. When folks talk with passion and fire in their bellies, a newbie coming right of the college thinks, wow! that’s the way to go. Recently, a distant family acquaintance was asking me about my opinion about recent surge in IPOs, bonds, and stock market rise. This kid will be graduating next summer (note: next summer, i.e. 2011) from an engineering school and has already got a decent job through campus recruitment. The salary cash flow has not started, and he is already planning to “get-in the market”. He was “researching” what are different methods to make successful “bets” in the market.
Long story short, I convinced him the best way to learn is by doing over a period of time. He had saved Rs 5000 from his pocket money. I advised him to exercise his path breaking theories with actual money. Well, all said and done, he is sitting on 60% loss. He was unhappy with me for not stopping him from making mistakes and encouraging him to “invest in market”. But I will give him brownie points for taking it positively and picking my brains by reflecting back on what happened. I shared my observations with him and thought I will summarize for readers of my blog. So here you go…
- Personal finance is very simple. Do not complicate it. Restrict your personal finance into three categories viz., (a) Savings for short term needs; (b) Insurance for unexpected expenses; and (c) investments for long term sustainable wealth creation. I am amazed on how much time folks spend on (a) and (b), and amazes me even more to see how complicated they make it. Both of these can be done is by at most two vehicles. You do not need 5+ insurances or 5+ savings accounts. Your total sum is still going to remain same! Breaking head and going bonkers over savings and insurance is not going to generate wealth. It is only investments that will give you long term growth. Learn more and spend time on your investments. I spend less than 20 hours in a year (yes, in a year) on savings and insurance. Any financial vehicle that that generates 8% or less growth is savings – they are not an investment.
- As an investor, “the most” important decision you have to make is how to manage your overall investment portfolio. It includes what asset mix you are comfortable with. You need to understand how these multiple assets fit into your objectives. For example, let us take the perennial hot topic of real estate. If you are paying EMI on your house loan, then why would you buy stocks of real estate companies? Haven’t you already invested in this asset class (assuming you consider it an investment – I don’t)?
- Selecting individual stocks or individual IPOs is not “the most” important decision. They are secondary. It should be automatically driven by your portfolio management process.
- Minimizing cost is very vital for long term wealth creation. For example, I am a proponent of accelerating housing loan payments. Why should I pay 9%+ interest to banks? The logic that, “I can get 15%+ return in market for my money” doesn’t work consistently for 15 years time period of your loan. By the time you finish paying bank loan, you would have paid 2x or more for the same piece. Basically, you threw away that extra money. You paid the cost! Unless you are like MIP, who tirelessly works hard, consistently over time, to make sure it happens.
- Consistently outperforming financial markets, market timing, and performance chasing are losing strategies. Anybody who promises to do that, the first thing you do is, run away. It comes at a hidden cost which will bring down your returns.
- The expectation for future long terms returns (consistent and sustainable) should be somewhat in-line with GDP growth + few more. For example, if India’s GDP growth is expected to be 7% to 9%, then the minimum growth you must target (realistically) for your portfolio is [7% to 9%] + [4% to 5%]. That should be your target, and you should be able to achieve it with low risk to your capital. If you go below that, then you must reflect what is wrong with your management process. As an individual, you can certainly attempt higher return targets, but know, it comes with risk of losing capital and additional effort. Free lunch does not exists!
- Broad or blind diversification is not an assurance against loss of capital. Remember, 50 stocks or 10 asset class in a portfolio will provide downside risk, but it comes at the cost of reduced growth percentage.
- Finally, we all talk about risk in investment or risk in personal finance. Risk has so many dimensions that we often select or measure based on what does not apply to individuals. Market risk, currency risk, company risk, profitability risk, revenue risk, government policy risk, and what not. Those are big words – talking about it makes you look smarter. A simple question you should ask yourself, “how it affects me directly – not indirectly”. You will find that those type of risk are least of your worries. The biggest risk you should be concerned about is “not being able to meet your financial goals over your lifetime”. Your personal risk profile is the only factor which should drive your personal finance or investment strategies.
I got a feeling that this kid understood the theory of it, but I did not good feel that he will stick to it or work on it. In my viewpoint, when your investment vocabulary consists of “get-in the market”, “getting out of market”, “betting of xyz company”, ‘investment horizon of 4 months”, then you certainly need more time to learn investing.
beginners guide, diversification, personal finance, portfolio, risk profile, target returns