Investing your way to wealth

I started my investment journey a decade ago when I bought my first stock. In the next 3 to 4 months, I accumulated around 5 stocks. 9 months into the stock market I was not able to understand the reasons behind volatility. I came to the conclusion that if 99% of the participants are speculating, fundamental investors like me have no place in this asset class. Also the ups and downs of the market, the notional loss was making me uncomfortable, and I chickened out.

Not knowing where to invest my savings, I bought an apartment thinking it would provide me better returns. Unfortunately the project got delayed for 8 years and the real estate market remained sluggish as well. I recently exited the project with inflation adjusted losses.

My journey with markets started again in 2019, this time, I didn’t go by my ignorance but by learning from marquee investors. I mean books.

By the way, when I say investing, I am only talking about long-term investing here, not trading. I look at things from 10 years perspective.

Okay, that’s the backdrop on how my journey started with investing, obviously not a good start, but I learned along the way. Can my learning be useful for you? read on and decide.

Prerequisites to start Investing

Before we talk more about investing, there are few prerequisites which one needs to understand and implement.

Good Health — Most won’t call it pre-requisite but I do, what is the point in becoming wealthy without good health, so first figure out ways to be healthy.

Good Skills — Unless you are born rich and you directly get into investing, focus on developing your skills, these skills will help you earn & save money, which is the raw material for investing.

Life Insurance — Once you have some earnings and by virtue savings, get a life cover, term life insurance is a must, rest are optional. I buy only term.

Health Insurance — Apart from your office health cover, get your own health insurance which includes your family. Life threatening diseases or accidents can sometimes wipe off your wealth. So make sure you have sufficient cover for the entire family.

Emergency Fund — Most investments come with some risks and volatility, example, when stock markets are down 50%, you don’t want to be selling your assets to pay your bills. So secure at least 12 months of your expenses in liquid funds (debt/FD).

Housing — I don’t consider buying a house as an investment anymore, the returns are poor. But from a psychological & security perspective, it is better to own a house first before starting your investment journey.

Asset Classes

There are various asset classes you can invest in, they differ by returns, risk levels, volatility, alignment to your psychic and other factors.

Gold

Gold is a secure investment and a good hedge against inflation. Between 1981 to 2000, it provided 4.57% CAGR returns, which is low, compared to interest rates that time and between 2001 to 2020, it provided 12.9% returns, which is decent. Since the returns are low even across a 20 years period (1981 to 2000), I would consider gold not a consistent performer.

Of course in extreme situations where your country gets into hyperinflation (like Venezuela, Syria, Turkey) gold is a very good hedge. And in a war-ridden country like Syria where you are possibly trying to get out of it, nothing better than having gold. If you happen to escape to a neighboring country, gold can still get you food there, equity/bond/property won’t.

Gold comes under a broader asset class called Commodity, which includes four categories: metal, energy, livestock and meat, and agricultural.

Housing

As investment housing doesn’t provide good returns. Rental yields are less than 3% and if you see the house price index below, property prices are increasing at an average of 3%, which is less than inflation.

Investing in land (plots) can provide better returns compared to buying a house, but be careful about illegal occupation, fake documents and land grabbing.

Equity

Stock markets are volatile hence the common man stays away from it. Of course in the last 2 years, things have changed, crores of new DMAT accounts got opened, thanks to Covid. But many of them will exit when the market turns red and volatile.

If you look at decadal performance of Sensex, you will notice that Equity provides consistent returns. CAGR between 1981–2000 was 15.38%, 2001–2020 is 14.36%, in the long run, equity always seems to be doing better.

Bonds

Bonds are financial instruments issued by government and public & private institutions. Typically the returns are slightly higher than fixed deposits if you include the tax benefits as well. And it comes with minimum risk provided you are buying AAA rated bonds.

As you see below the yields have dropped from 14% in 1998 to 6% in 2018, it barely covers inflation. If you wish to take almost zero risk then bond markets are for you, but don’t expect good returns.

Bitcoin

Bitcoin is a relatively new asset class and it is based on blockchain technology. Nobody knows where it will land in 10 years from now, what will happen if sovereigns start releasing their own cryptocurrency or put a blanket ban on cryptos. Current pricing of bitcoin is largely based on its scarcity (only 21m Bitcoins can be mined), technology, decentralization, adoption by Elon et al and euphoria around it. There is no intrinsic value to Bitcoin, it is whatever you perceive.

And it is volatile as you can see in the below one year chart.

Bitcoin comes under a broader asset class called Digital Assets, which includes Cryptocurrency, NFT, Virtual Estate in metaverse etc.

Mutual Funds

Those who find it hard to invest directly in stocks, mutual funds are a very good option. But know that 95% of the mutual funds don’t generate returns above nifty (aggregate returns by top 50 companies in India), which means performing fund managers are few and far between. Choose them carefully based on past performance, expense ratio and their investing philosophy which in some sense aligns to yours.

Compounding

Look at the chessboard below. If you start with 1 grain of rice in the first box, and double thereon, can you imagine how much will be the count at the end of the 64th box? I bet your number will be nowhere close to the answer. That’s the power of compounding.

Granted that your net worth isn’t going to double every year, but even if it grows at 15% CAGR, it doubles in 5 years, at 12% it doubles in 7 years, which is great.

Warren Buffett apart from being a skilled investor, he has given himself 8 decades for compounding to work. Majority of his net worth came in after he turned 50. See the chart below.

Smartness vs Behavior

Doing well with money has little to do with how smart you are and a lot to do with how you behave. Here is a story from the book Psychology of money.

Savings

Money is the raw material to make more money. Unless you cultivate the habit of saving, it will be hard to begin your investment journey. If your current lifestyle is not allowing you to save, change it, get help from your well wishers to change it.

Contentment

When you have made enough money, how do you make sure that you don’t lose it all? Simply by being content. When you are satisfied with what you have, you naturally avoid undue risk, you stay away from fads and blowups.

Here is what Warren had to say on this.

Concluding thoughts

Investing is a single player game, it is you vs you. Your IQ, habits, behavior, temperament, belief system, will either help you or harm you. Read about other successful investors, their investing philosophy, pick and choose what works for you, start small and build on it.

Happy investing!!