This blog is contributed by Shivam Dave, Linkedin : @shivam-dave-211a71175. He also has his personal blog pages @ earningunderway.com. Shivam is passionate about investing, eager to learn and to succeed.
“You don’t have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long, time.”
-Charlie Munger
Compounding is beautiful !
Wealth creation must be more about the process, than the end goal. The greatest personal fortunes created were not achieved in a fortnight, but it takes years of hard work and experience. The greatest investor of all time Warren Buffet invested for the first time at the age of 11 and regrets he didn’t start earlier!
Wealth creation is something relative in nature, one might be satisfied with the money he/she amasses from their job, one would be satisfied only with their business per say, then comes the third way: Investments- A guiding path to the optimum creation of wealth.
Let us just stick our discussion to creation of wealth through investments and experience the snow-ball effect of Steady Compounding.
creating wealth over time through long term investments in stocks, bonds, PPF (Public Provident Fund), Real estate/REITs might seem to be complicated in the starting stages, but it is a simple process when combined with a disciplined and a holistic approach.
Compounding
Before beginning with our discussion on the various asset classes and how to allocate capital for the same, let us first understand how compounding works.
With this method, one is just not earning interest on their principle, even your interest earns an interest. It is when you add the earned interest back to your principle (principle + interest) which further makes more money, hence compounding your returns.
Formula:
For compound interest, Amount of money , A , received after t years is
A = P x (1+ r/n)nt Where,
while for simple interest, it is
A = Px (1+ rt ) , where,
A= amount of money accumulated after n years
P= Principal amount
r= rate of interest
t= time period
Now we have clearly identified who wins in the longer run. The answer being compound interest. Now with great success comes discipline and frugality. One must not end up spending the money earned from the principal and must invest it back to enjoy the comforts of the snowball effect.
As we’ve understood the secret behind success from investments, where do we exactly use the compounding effect and make super normal returns?
Yes, equity investments. The greatest investor Warren Buffett strictly follows compounding and let’s time do the magic.
To enjoy the fruits of investments. One must reap earlier. Key to great wealth is to start investing early, not the amount not the company, but time.
1. Start Early
The below illustration represents the importance of starting early, and how it would benefit in the longer run. It's amazing so see, that first investor started 10 years earlier, and invested only for 10 years. The second investor started 10 years late, but continued to invest for next 30 years. Yet, the first investor accumulated more wealth !
2. No matter what, buy right and sit tight
We live in a dynamic and interconnected world where not everything goes on smoothly always. Slight knee-jerk reactions effect the global economies, but stock markets digest that news and get back to the winning ways. It is not always about timing the market, but the time in the markets. Here is world market index over last many years, showing volatility and ups & downs of the market. You can't buy every dip and can't sell every peak.
3. Let the compounding work for your
Compounding is an effect which would test the patience of any investor. The beginning years would not look so exciting in terms of the money made, but it would reward. There is some reason why Albert Einstein called compounding the eighth wonder of the world!
To create multi-baggers and super normal returns one must take the risks of investing in equities. They surely are a treasure chest for those who are ready to put in the work, and money of course!
There are two ways of investing in equities: Direct and Mutual Funds (Indirect)
Investing in equities can be rewarding, but more often retail investors burn their fingers while investing by themselves due to lack of knowledge at times or sometimes in timing the market. In these cases, it is best to hand over your money to professionals/fund managers.
Direct investing means you directly invest in the companies by your research and conviction.
Indirect investing is through the means of mutual funds, run by professionally SEBI registered fund managers.
Equity Mutual Funds- MF’s pool funds of investors and invest in the markets. Based on the various sectors, market cap and the theme of investing you have various mutual funds of many companies.
Tip: Certain mutual fund companies might specialize and be the best for a particular theme of investing, hence it is important to understand the fund manager, the previous track record of that mutual fund to generate alpha.
By Market Capitalization | Large, Mid and Small |
By diversification | Multi cap, focused, sectoral, value oriented, international etc. |
By sector and themes | High dividend yield, banking, technology, ESG, Energy, auto etc. |
Mutual funds do generate extraordinary returns for their investors and create a lot of wealth for their investors.
The above table shows the examples of some mutual funds and how great they are in the form of an investment in making superior returns and beating inflation.
Direct investing also creates superior and sometimes more better returns than a mutual fund. The reason being stringent rules than mutual funds need to follow. The Association of Mutual Funds in India (AMFI) have laid out some rules that have to be followed. Fund managers cannot go over the board with the companies they invest in keeping in mind the interests of the retail investors.
Direct equity investing holds more risk, which is directly related to higher returns.
The special case of Wipro:
1990: 100 shares
1992: 200 shares (1:1 bonus on 12-08-1992)
1995: 400 shares (1:1 bonus on 24-02-1995)
1997: 1,200 shares (2:1 bonus on 20-10-1997)
1999: 6,000 shares (5:1 split on 27-09-1999)
2004: 18,000 shares (2:1 bonus on 25-06-2004)
2005: 36,000 shares (1:1 bonus on 22-08-2005)
2010: 60,000 shares (2:3 bonus on 15-06-2010)
2017: 1,20,000 shares (1:1 bonus on 13-06-2017)
So, 100 shares bought in 1990, if kept untouched until 217 they would result into 1,20,000 shares!
Wealth creation is not about the end, it is about how one enjoys the process with utmost discipline and patience.
As rightly said by one of the greatest investors India has seen Late Rakesh Jhunjhunwala, “Your patience might be tested, but your conviction will be surely rewarded!”
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