Friday, October 18, 2013

The Best Route to Building Wealth

Best Route to Building Wealth - The title sounds like one of those Spam Emails we keep getting in our inbox with lofty claims about making us millionaires, isn’t it?

No, I am not one of those guys and I can assure you that this article is not a get-rich-quickly articles. However, one thing I can assure you is that, this article is going to give you pointers on how you can actually build wealth. That is not going to happen overnight. Slowly but surely you can achieve your dream of being wealthy..

Are you curious?

So, What is a Sensible Way to Build Wealth?

If you talk to some random guy to find out ways to build wealth you may get any or all of the following ideas:

1. Invest in Property
2. Speculate in Stocks
3. Find Get Rich Quick Schemes
4. Start a Business
5. Play the Lottery
6. Switch to a Better Paying Job
etc...

Let’s take a moment and think about these ideas - Are they sensible? Except Switching to a Better Paying Job, the other ideas are either purely based on luck or require a huge capital investment.

So, What is the Possible Alternate?

Investing in the Equity Markets on a regular basis is the best way to build wealth.

Quick Trivia:
You may be wondering why I have put "Speculate in Stocks" as item no. 2 in the list above but say Invest in Equity Markets in this section, aren’t you? Speculating means buying some random stock and praying to god that the stock price goes up. Investing means, doing proper research, identify a good stock and then investing in it with a timeframe in mind...


What Prevents us from Being Good Investors?

Everyone would like to be good investors but unfortunately things are not that simple in the Investing World. Some of the most common problems we face are:

1. We all have a full-time job
2. Plus, we spend the remaining time (beyond our office hours) with our friends and family
3, Time Required to acquire knowledge about Equity Markets is pretty high
4. Understanding the Equity Markets is complicated and requires dedicated effort (which points us back to problem no's 1 & 2)
5. Ability to come up with lump sum capital amounts to invest in options like Real Estate or Starting a Business

Are you one of those people who will fall under many or all of the problems listed above? If so, this article is going to give you a simple solution to overcome this problem...


So, What is this Best Route to Build Wealth?


The best route I would say is to start a "Systematic Investment Plan" on either a good Index Mutual Fund or an Index Exchange Traded Fund

Why the Systematic Route?

As I have said numerous times in this blog, investing on a regular/monthly basis is great for two important reasons:

1. The Monthly Outflow of funds is not huge. You can start with amounts as small as Rs. 1000/- per month
2. You have the ability to average out your investments in the long run irrespective of market volatility

Benefits of Starting an SIP in an Index Mutual Fund or Index ETF:

The Following are the Advantages of following the above said option:

1. You get wide diversification in a single package
2. ETF/Index Funds have low operating expenses
3. ETF/Index Funds have low internal trading expenses
4. ETF give you control of your exposure to the specific asset classes you want
5. When you buy an Index ETF, you know what you are getting, the performance of an index
6. You will most likely get average returns
7. You won’t have to worry about monitoring the performance of a fund manager
8. The rebalance is automatic without you worrying whether by selling, you will miss out on a manager’s "hot streak"


What kind of returns can you get?

The thing about equities is that you won’t know whether you will be getting 3%, 6% or 9% in future. That is why all stock market investments come with the mandatory disclaimer that says "Past Performance may or may not be sustained in future". However, if we take history as a yardstick to predict future performance, we can conclude that in the long-run regular investments in the Equity Markets can out-perform all other investment classes - Always.

For Ex: If you had Invested in an Index Mutual Fund or ETF that is based on the Nifty (National Stock Exchange) Rs. 5000/- every month starting 1st January 2002 (Almost 12 years ago), as on date your investment would be worth over 1.5 crores. The amount you invested over the past 12 years would work out to Rs. 7,05,000/- at the end of last month.

As you can see, your money has more than doubled in 12 years, which is great, isn’t it?


Will you lose money?


Let us be realistic here. Stock Market Investments are really risky and you may end up losing money if you want to stay invested only for a short duration. For ex: If you had invested a lump sum of Rs. 10,00,000/- in Jan 2008 your investment would have been worth around 8.5 lakhs in May 2008 and less than 5 lakhs in December 2008. Even now, your investment would be only worth around 9.5 lakhs as of today.

Whereas if you had invested Rs. 5,000 every month starting 1st January 2008, your investment would be worth 4.2 lakhs as on date while your investment would have been 3.5 lakhs. Even though the profit is only Rs. 70,000/- over the past 5 years, you were able to average out your losses because you stayed the course and invested every month. If you continue to do so, for another 5 years or so, your investment would definitely be worth a lot more.
To Summarize: Chances of Not Losing Money increases with TIME

Do ETF's and Index Mutual Funds Pay Dividends?

Yes, they do. As Index Mutual Funds and ETF's only invest in the most profitable and large corporations in the country, there is a good chance that these companies declare good dividends every year. Index Mutual Funds and ETF's declare Dividends on a regular basis depending on the dividends they receive from the companies they hold stocks in. Remember that this dividend is at the discretion of the fund manager and will only happen if the economy is doing well. For ex: During the crisis between 2008 to 2010 most ETFs did not declare dividends but the past couple of years, they have declared decent dividends.

What Other Benefits Does Investing in Index ETF or Mutual Funds have?

India is an emerging market. Our economy is growing. As our country progresses, newer conglomerates come into the picture. When the country does well, the underlying companies that support the country do well too. When new companies replace old ones in the Index because of their growth, you don’t have to worry about the same because your ETF or MF automatically does the replacement and you get the benefit. For ex: In 2011, Coal India and Sun Pharma replaced Reliance Communications and Reliance Infrastructure in BSE Sensex. You can read the article I wrote at that time "By Clicking Here" to learn the why part. Since Coal India and Sun Pharma were better prospects, switching to them was a good idea for the Index and would have been a good idea for the investor too.

Some Final Words:

Building Wealth is a time taking activity and you need to invest regularly and religiously for at least 10 or 15 years in order to accumulate and build Wealth. That is exactly why I suggest this route because these funds are not dependent on one fund manager’s brilliance or ability to pick winning stocks. These funds move along with the country's economy. For a country like India which is still in growth mode, this idea is all the more impressive.

At the end of the day this investment comes with a risk. If you are willing to take the risk this is a wonderful opportunity.

Before I wrap up, let me say that if you feel investing in the stock market is not your cup of tea due to the risk, at least start a monthly "Recurring Deposit" with any bank for whatever small amount you can afford every month. Just let the money accumulate for 5 or 10 years and you are sure to save up a good amount of money.

Happy Accumulating Wealth!!!

2 comments:

  1. With due respect to your knowledge, I beg to differ. I have invested in number of mutual funds over a long time. None except for two or three have given any satisfactory returns. My friends and relatives have invested in different mutual funds in which I have not invested. Same is the case with them. I have analysed this reason in depth and have come to the following conclusion: If a person or a mutual fund promises you returns of more than 15%, that means he has to earn around 25% to recover his running expenses and administrative charges such as salaries to employees. This is difficult, if not impossible. Bank FDs are the best. At least I have it in writing on bank FD as to how much amount I would get on maturity. I may be wrong but this is my opinion and I will stick to it

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    Replies
    1. Hi Vinod - You are absolutely right with your opinion and by all means you have the right to decide what is best for you based on your risk appetite. However, I beg to differ on a few points:

      1. Mutual Funds do not promise returns. The people who actually sell fund products false advertise on the kind of returns. Funds are prohibited from advertising that they can promise a certain rate of interest

      2. A Fund house does not need to maintain a spread of 10%. Usually the expense ratio of funds is between 1 to 3% depending on the type of fund. Funds that are actively managed by a full-time fund manager and a team of experts who spend their time researching on what stocks to buy/sell have a higher expense ratio than others.

      3. The type of fund I have proposed here is an Index ETF or a Mutual Fund that is based on an Index where the fund manager does not actively manage the corpus. All he has to do is maintain a ratio of stocks that simulate the index which is pretty straight forward. Such funds (both ETFs and Mfs) have the lowest expense ratio which will be less than 1%. Any returns the stock market gives minus 1% will be your returns

      4. Since the stock market carries the risk of losses is the reason why I have clearly mentioned that the investment carries risk. For the short term trader the stock market can either be hell or heaven. There is no middle ground here. For the long-term guy, as his investment stays put, his chances of losses go down and his chances of profit go up. But, there is always a risk. If you waited for 12 years and during the 13th year when you actually want to sell your investment and if you are unfortunate enough to try to sell when the market is beaten down due to a recession, you may not make that much profit. but still, this is a risk you take by investing in the stock market.

      Investing in Bank Fixed Deposits or Recurring Deposits is an assured way of making money but one thing you need to remember is that the interest you earn from these deposits is fully taxable. So, if you are someone who is in the highest tax slab, if you earn a 9% returns on your FD, your effective returns after deducting taxes is only 6%. In the long run, the equity markets can give you much more than 6%

      Thanks for being honest about your opinion and I really appreciate it.

      Anand

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