One Big Problem With Compounding & Why You Cannot Become A Long Term Investor!!

I have been a hard-core follower of the concept of compounding. And like Albert Einstein, I believe that it is the 8th wonder of the world. Using this concept, you can make your money work for you rather than working for it.

But there is a problem with this concept. A big problem!

The problem lies in the fact that this MAGIC of compounding does not begin during the first few years. For example, you invest Rs 10,000 in a company’s shares, which is capable of earning a realistic 10% every year. This would mean that next year, a neat sum of Rs 1000 would be added to your original investment (assuming linear returns for theoretical purposes). But now if this position grows to almost Rs 1,00,000 after 15-20 years, because of dividend re-investments, compounding etc, then going forward, a 10% return would mean Rs 10,000. This is not much. But compared to what it produced in first year, it is almost 900% more. And that is the problem with compounding. The money-making-magic begins after almost 15 years.

Magic of compounding
Compounding: Magic Begins After 15 Years

Similar is the case with dividends. Annual dividends paid out by good dividend paying companies after 15 years would be almost equal to what they produced in first 10 years combined!! And that is one hell of money when you understand the real meaning of the previous statement.

So if you consider yourself to be a really long term investor who can stay focused for decades, then you need to understand that real benefit of compounding begins only after year 15. And frankly speaking, it is unlikely that Rs 10,000 investment is going transform your life over a 15 year period of compounding. Rather, it is during the next 15 years after that the magical wealth creation starts taking place.

And that is why, we need to understand that one should accumulate as many shares as possible, of few good, stable and reliable companies as core holdings during the first 15 years of one’s investment career. Once done, the magic begins to unfold after year 15. And believe me, with most of your investments, the years 26-30 would produce much more wealth than the first 25 combined.

This shows why most people are unable to keep faith in long term investing. Its simple but its tough. And it requires a lot of patience from you. I personally aim to become a long term investor. Currently I am in accumulation mode and prefer bear markets to bull markets. (Evil Disclosure: I continuously pray for market corrections) 😉

What are your thoughts? Do you think its easy to wait for 15+ years to allow compounding to show its magic? Or do you think that its better to go for short term trading?

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Long Term Investing Vs Short Term Trading

Do you believe in long term investing? Or is it that you do not believe in short term trading? 
 
Irrespective of what you and I believe in, the fact remains that it’s a big mistake to simply ignore short-term(ism). Short term trading can deliver quick returns. Period. But are these (eye-popping) short-term performances sustainable over long term? And why is it that after every crash (2000, 2008, etc), it is the traders who are wiped off and it is the long term investors who are not? There must be some reasons why traders have such high (market) mortality rates?
Lets look at it from another perspective. When we talk about investing or trading, what we are indirectly referring to are the time horizons. Now these time horizons are relative. Your long term can be short term for someone else. One of my close relatives has been investing for last 30 years. According to him, anything less than 10 years is short term!! And just one of the stocks in his portfolio happens to be HUL (Hindustan Unilever Ltd). After adjusting for bonuses, splits and dividend re-investments, his average price per share works out to be Rs 2.00/- (No…it’s not a typo); and HUL is currently trading at around Rs 570. Add to it the current annual dividend of Rs 7.50 per share. i.e. He has a capital appreciation of 28,400% and earns 375% (on his original investment) in form of dividends every year. Now can a trader match that? That too, year after year? One may argue that one can. But figures like 28,400% & 375% make it really hard for traders to challenge this long term investor’s approach of terming anything less than 10 years as short term. 🙂
Now these time horizon also depends on one’s risk appetite. It is a known fact that in short term, markets are volatile i.e. risky. So if one cannot take much risk, then he is not suited for short term trading. He is better off investing for long term by picking up good, solid companies or investing systematically in mutual funds. The longer you have to invest your money, the bigger risks you can take. If you need money in next few years, you should take a more conservative approach and put it in banks or other safer investment products like Bonds, RDs, FDs, etc.
For an average investor like you and me, anything more than 5 years can be termed as long term. Five years is a long enough time to assess whether a company is doing good or not. I personally define my long term as more than 10 years. What about you?
 
Disclosure: No positions in shares of companies mentioned above.

You Only Have 20 Shots Left

Imagine a situation where you are allowed to make just 20 investments in your whole life. Tough… Isn’t it? Would you like to find yourself in such a situation? To be frank, it would be a very uncomfortable and stressful situation and I would personally ‘not want’ to be in such a situation. But fact is that when we are investing in a particular company’s shares, we should ‘assume’ ourselves to be in such a situation. To know why, read on…
Mr. Buffett once said,
“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”
 
Warren Buffet 20 Punch
Only 20 Investments To Make | What Will You Do?
 

Just think of it in this way. You are just allowed to make 20 decisions in rest of your life. Now what will you do? You would ofcourse pick and choose your ‘decisive-situations’ carefully and would take a decision only when you are more than 100% sure.

Now, this 20-punch approach is quite opposite of my personal approach of taking a balanced approach (using MFs, direct stocks and PPFs, RDsetc). But the fact is that I am neither very confident of my stock picks as Mr. Buffett, nor do I consider myself to be capable enough to regularly beat Mr. Market. And hence I have modified my personal investment approach in accordance with my own limitations. But atleast in this post, lets keep my views aside and focus on how exactly can this 20-punch approach be helpful. 🙂

You might argue that even Mr. Buffett would have made more than 20 investments in his life. So how can he argue for just 20? Here we need to understand that 20 is just a number. It is basically a guide as to what one should do before making any investment. So just have a look at your portfolio. If you were allowed to make just 20 decisions going forward, how many of your current holdings would you keep? And if you own more than 20, which are the companies you would get rid off as soon as possible?

This small activity of thinking in 20-slot mode helps in valuing our each and every transaction a lot more than what we would have normally done. And that is the whole purpose of this approach. In realty there is no limitation to number of trades you can make. But just imagine how careful you would become if there were such limitations.

And here is how Mr. Buffett choses his stocks (atleast some of the times):

“It’s not because I calculate some precise P/E ratio or book value ratio, but because I have an idea of what the company will look like in five (or ten) years.”

What are your thoughts? Which companies would you chose if you were only allowed to make 20 transactions in rest of your life?

 

Stable Investor Turns Two

Stable Investor has turned two. But frankly speaking, it seems a lot more than just two years. 🙂 Before Stable Investor came into existence, I used to write about stock markets on an ad-hoc basis on my personal blog. But Stable Investor has now turned that interest into something more special for me. I would be honest with you guys. I could have continued or discontinued writing during the last 2 years. But when I saw people taking part in discussions about what I wrote, it gave me a big high and a renewed motivation to continue working on the site. 

I clearly remember that when the site had turned 1, I did a special post thanking everyone. At that time, SI had close to 100 email subscribers and around 475 fans on FB page. As of today, the number of email subscribers has risen to almost 1000 and fans have also exceeded 1000. Though these may not be big numbers, for me, these numbers, your comments and reactions on FB page provide an assurance that there are atleast a few dedicated long term investors, who are reading and listening. And that in itself is something very special for me.
 
And to help me improve Stable Investor, I request you to spare just two minutes of your precious time and fill out a survey of 6 simple questions. You won’t get any prizes, but your answers to these questions would help me improve Stable Investor.
 
So, click on the red button below to launch the 2-minute survey:
 
Thanks.
 

10 PSU Banking Stocks – A Tracker Portfolio

No matter how much we avoid, there is no denying the fact that many (or rather most) Public Sector Banks are currently available at valuations which are mouth watering to say the least.
PSU Banks Stocks Worth investing now
PSU Banks | Can they make money for your portfolio?

Beware – The tone of this post might make you feel that this post is a recommendation to buy the stocks discussed. But that is as far as it can be from the real truth. It is your money. Weigh your options before investing your hard earned money anywhere.

Now I completely understand that there are some very big concerns like –

  • Deteriorating Asset Quality (Rising NPAs)
  • Competition from existing Private Sector Banks like HDFC, ICICI, Axis, Yes, etc.
  • Increased chances of new aggressive corporates like Reliance, L&T, Aditya Birla getting banking licenses

And every time I open a business newspaper, all I get to read is about the financial sector, is related to rising problems of public sector banks (PSB). And how the NPA issue is likely to continue for some more quarters to come. And if you do track reports by brokerages, you would know that most of these are begging their clients to stay away from PSBs and to park their funds in private sector banks. So all in all, its quite obvious that currently, the sentiments surrounding PSU banks is quite negative and it may not be a wise step to expect any kind of re-rating of this sector. But when one sees Price to Book Value multiples of 0.80, 0.50 and even 0.30, then one is forced to wonder whether things are really that bad or is it a clear case of over-pessimism?

Now, I personally feel that though things might be pretty bad for these banks now and for next few quarters, there is a reasonably good chance that they might improve if one is ready to hold onto a few of them for next 3-5 years. I am not saying that these will be multi-baggers. And I am also not saying that these will not be multi-baggers. All I am saying here is that these would give returns which should easily beat the returns given by other riskless investment vehicles like FDs, RDs, NSCs etc. Now you must understand that I am trying to make a prediction here. And fundamentally, that is not a wise thing to do. But just to keep a check on how well my predictions pan out, I will pick a few large and small public sector banking stocks and keep a track of them every 3-6 months.

And to track the PSU banking space, I am picking 5 large and 5 small(er) PSU banks.

Larger PSBs

  • State Bank of India
  • Punjab National Bank
  • Bank of Baroda
  • Canara Bank
  • Bank of India

Smaller PSBs

  • Syndicate Bank
  • Allahabad Bank
  • Corporation Bank
  • Andhra Bank
  • Vijaya Bank

 

What are my expectations from this collection of stocks?

I expect them to collectively give better returns than index (Nifty50) in next 5 years.

 

How Do I plan Tracking it?

Starting today, I will create an equal weight index of these PSU banks and track it against Nifty50 once every 3 months. This hypothetical index may go up and down in near term. But at the end of 5 years, I believe that it would provide better returns than the index as a whole. And this would be without any consideration for generous dividends which PSU banks dole out everytime.

 

Am I investing my own money in these stocks?

Not in all. But I have long positions in a few of them.

(Disclaimer – I also have long positions in few Private sector banks as well.)

For record, the prices of all of these stocks as on 10th November 2013 are given in table below. A notional sum of Rs 10,000 would be invested in each of these names to purchase shares (no. of shares may be fractional). This sum of one lac invested in 10 stocks would then be monitored and benchmarked against Nifty50 every 3rd month.

PSU Banks stocks portoflio

The exact reason of choosing these particular banks is not important here. I am just trying to gauge whether the kind of theoretical undervaluation which is being witnessed in PSU banking space currently, will be corrected in next five years or not? But, the top 5 banks in the list are the 5 largest PSU banks. Rest five have been chosen without any particular reason or because I fancy their names. You can choose your own set of PSU banks in case you plan to track them independently.

Another way to track the broad changes in PSU banking space is to keep a track of Nifty PSU Bank index. This index is made of shares of 12 government owned banks.

So what do you feel? Will the PSU banks make money in next 5 years or they are headed the Air India-, BSNL-, MTNL-way?

(Updated in February 2016)  – You can my views about fall in share prices of PSU banks in article – Are you worried about falling Bank Stocks?

Mailbag: I want to gift a Dubai trip to my wife. How do I fund it?

I think that after reading the title of this post, many of you would have become interested in knowing more about the person behind such a ‘noble’ thought. 😉 
 
Unfortunately, all I know is his name – Amir. Ever since I started a section to handle personal finance questions, this had to be the most interesting question and I decided to address it as fast as possible. For the benefit of readers, I would summarize Amir’s question below –
 
Amir’s 5thWedding Anniversary is due in 2015. He wants to take his wife to Dubai for 5-6 days to mark this special occasion. He also wants to make provision for shopping in Dubai. His question isn’t clear as to when exactly does he wants to go, but I would assume that it’s in second half of 2015. He also says that he can pre-pone his trip to take place in 2014. But that according to me might defeat the very purpose of 5th year celebrations. He wants to know whether he should fund this trip using credit cards or share market trading.
 
How To Fund My Dubai Trip?
 
I checked a number of flights, hotels and holiday packages for a 6 day trip to Dubai. And my preliminary research showed that it would cost around Rs 55,000 per person for a decent stay in Dubai for 6 days (including airfares). Additionally, one needs to pay another Rs 5200 per person for Visa. This brings the total for two persons to approximately Rs 1,21,000. Now the next figure which I would add to this amount can vary from person to person. It’s the shopping budget. And as far as ladies are concerned, any budget for shopping is less. So to keep matters simple, I assume that the couple would shop for around Rs 50,000 plus. This takes the total to Rs 1,71,000. 
 
And just to make provisions for contingencies, travel insurances and other unforeseen expenditures, I have decided to round off the estimate to Rs 2,00,000.
 
 
 
Now, Amir failed to provide the following important information(s):
 
– Monthly Surplus (Income from all sources – Investments – Expenditures)
 
– Exact time of travel
 
– Shopping Budget 🙂 (I have already played safe with my assumptions here).
 
Now to decide how to fund this trip, we need to know when Amir needs to travel. I will assume that he plans to travel between Sept – Dec 2015. This means that he needs to be ready with funds by August 2015. This leaves us with 21 months (starting December 2013). Now I still don’t know his monthly surplus. But what we do know is that Amir needs to arrange Rs 2,00,000 in 21 months.
 
Now a simple recurring deposit of Rs 8900 per month for next 21 months, earning a 7.5% interest per annum can do the job. It’s that simple. 
 
As far as taking a Credit Card debt is concerned, one must understand that it is the costliest form of debt and at times can cost you more than 35% per annum in interest costs. And you don’t want to pay 35% interest on Rs 2,00,000 for next few years, isn’t it? 🙂
 
Another option which Amir mentioned was stock markets. I would not suggest this option even though you have close to 2 years as your time horizon. I personally think that over a short term (less than 5-7 years) stock markets can be risky with high chances of capital erosion. You may be a good stock picker and may be able to make the required amount in less than 21 months. But I have no access to knowledge about your stock picking abilities. 🙂 And also, just imagine a situation that you decide to go ahead with your decision of making money in stock markets to fund this trip, and god forbid, markets take a dive in July 2015 and you are left with inadequate funds to pay for your trip. What will you do then? You may decide to take Credit Card debt and go ahead. But why would anyone want to take chances with such an important event of your life? It’s better to keep it simple and go for a simple recurring deposit.
 
Note – I have made assumptions regarding the trip and shopping expenditures. The real costs may be higher or lower, and consequently, your monthly RD contribution would also be higher or lower. Consider this to be disclaimer from my end. I don’t want your wife to come after me for miscalculating  her shopping budget. 🙂
 
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Indian Market’s New Life Time High & Why Stable Investor Was Silent?

First of all my apologies for keeping Stable Investor so un-updated for last one month. I know there should not be any excuses for something you are really passionate about, but this time around I was busy with preparations for the biggest investment of my life. No, I am neither buying a house nor a company. I am getting married this month. 🙂 So with so much preparations going into a typical Indian wedding, it’s the site that is paying the price with inactivity. But the silence has been broken and I intend to keep it that way.

(I even received an email asking me whether I had died because of some wrong stock pick) 😉

And it seems that just after the stocks in Dead Monk’s Portfolio were disclosed, markets as a whole decided to look at future through rosy glasses. Markets over the last one month have just been doing one thing, i.e. going up. And in that process, they have actually managed to hit new life time highs. And to be frank, markets are not looking cheap at all. With indices commanding multiples in excess of 18.3, this may not be a very good time to think about entering the markets. (Disclosure: I don’t believe in timing the markets much. Read why here). But as it always happens, when markets start moving upwards, retail interest in markets starts rising. And this once again happening now. People all around us have started asking for a hot tip or two to make a quick buck here or there. And this is how the process of losing money in the long term begins. But let’s keep that discussion for another day.

Sensex Nigh Highs
Markets Making New Highs. Reasons? Unknown.

I have been a little off-track for last one month and am yet to understand as to what exactly changed in the Indian economy that is forcing stock markets to run away like this. Is it because of new RBI Governor? Or is it the US’s delay in stopping the fund flow? Or is the economy really moving towards a better-than-yesterday scenario? Or is it that market expects some decent outcome from the coming general elections? Sadly, I don’t have answers to any of these. I am not a pro on answering any of these. But I would do what I am capable of doing. I would continue focusing on my long term plan of wealth creation. I would try my best to do things which I believe I am not-bad (if not good) at. I would continue to keep a hawkish eye on developments linked to stable, solid companies that form the core and satellite of my portfolio.

And since I am busy with my personal life, I would continue funding my SIPs as they having been going on for last few years. I would also continue accumulating funds in RDs which would help me make bulk purchases of stocks when markets crash in near (or far) future.

So, for the time being, that’s the update from Stable Investor’s side. Regular posts with more financial content would commence soon. Till then, have a safe, happy and a noiseless Diwali.


And do share details of what you plan doing when markets are making new highs.

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9 Stocks – Dead Monk Portfolio

After procrastinating for months, I am finally sharing names of companies which are part of Dead Monk’s Portfolio (DMP).

But before that, here is a gentle reminder of what to expect from this portfolio.

In previous post discussing (or rather rethinking) Portfolio Structure & Composition, I mentioned that for DMP, I would stick with Core Satellite structure and a maximum of 15 stocks in the portfolio. You can read more about the reasoning here.
core satellite portfolio of stocks
Structure of Dead Monk’s Portfolio
In a follow-up post deliberating the need to find more dividend paying companies & stocks from other sectors, I mentioned that most of the stock in existing DMP pay decent dividends. But just to be on a safer side, I would also keep an eye for new dividend candidates, in case I decide to kick out some of the existing stocks. There is good bad news and bad news on this front. I have removed one dividend payer – Graphite India from the core. And next bad news is that I have not found a suitable replacement for this company. 🙁 Hopefully, I would find it soon enough.

Another point to note here is that no. of stocks in DMP has been reduced from 15 to 9. This is because of one above mentioned removal, as well few more removals from satellite part of the portfolio. I have also not named specific companies in Misc (Satellite) part of the portfolio. This part deals specifically with short term and speculative bets and is more dynamic (changing) than rest of the portfolio.

Out of the 9 stocks, 7 were part of original portfolio too. Two new entrants are marked with a ‘*’.

So here are the 9 stocks –

ONGC

Clariant Chemicals

Balmer Lawrie & Co.

Tata Investment Corporation

Axis Bank

ITC *

Yes Bank

IDFC *

Cairn India
9 stocks of portfolio dead monk
9 Stocks in Dead Monk’s Portfolio
I would have personally loved to add more stocks in this list to achieve higher diversification. For record, only 4 sectors namely Energy, Chemicals, Financials & FMCG are part of this portfolio. You can say that this kind of diversification may not be sufficient. But this portfolio is in line with my own risk appetite and understanding of certain sectors. I would prefer to stick with only a few companies and business which I understand rather than venturing out dangerously in areas I don’t understand. I may be missing out on potential multibaggers here. But that is a price which I am ready to pay to have a stable, ever growing portfolio of stocks which I am ready to hold for decades and not just years.

Note – You might say that this portfolio is not stable at all. It has been reworked in less than 2 years itself. Correct. It’s true that I have taken the liberty to change (reduce) the no. of stocks in the portfolio. But this is because I myself am learning newer things about myself and my personal investment psychology. I am arranging a long term portfolio around my personality rather than it being the other way round. Anyways, most of these 9 stocks were already a part of the original portfolio. So change is there, but it’s not an earth shattering one. 🙂

I have already covered about most of these companies in detail as provided in a list below.


One particular business which has seen some drastic changes in last few months is Clariant Chemicals. I am personally not very sure as to how to take a call on this one. But because of management’s proven track record and respectable dividend policy, I have decided to stick with the company for time being. But you can take a call yourself by reading my thoughts on Clariant Chemicals and also weighing the consequences of some recent developments (link).

As far as ITC is concerned, please be aware that this is a business which I like, but maybe not at current valuations. So one can wait for valuations to come down. Or if one is investing for years to come, a steady and disciplined buying of ITC’s share can be considered.

I would leave you with these thoughts and this ‘link-heavy’ post. Rest assured that I have put most of my money where my mouth is. 😉 Do share your views about these nine companies and also share your list of stocks which you would be buying for next few decades.

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