A few months back, I attended a conference on Financial Planning in Mumbai. One of the speakers at the conference was a well known CEO of an Asset Management Company.
What I liked about his presentation was that when everyone else was talking about financial planning for individuals, he opened his speech with a very strong statement: Warren Buffett did not do any financial planning!
What I liked about his presentation was that when everyone else was talking about financial planning for individuals, he opened his speech with a very strong statement: Warren Buffett did not do any financial planning!
And this set the tone for rest of his presentation.
Now, beware of acting on that statement alone. We are not Warren Buffett. Right?
And as an common people, we do need to do atleast some bit of planning, when it comes to money.
And as an common people, we do need to do atleast some bit of planning, when it comes to money.
But the main theme of the presentation was to demonstrate the power of equities and more importantly, the real meaning of investing.
And he shared a very powerful example, which clearly showed that the stock markets do have the potential to change our living standards.
In rest of the post, I will try to recreate that example here:
Part 1:
Suppose you have Rs 8 lacs. And you want to use this money to buy a car.
Now which car can you buy in that amount?
Probably…
A Honda Amaze (a higher end version costs about Rs 8 Lacs)
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| Honda Amaze – A Mid Segment Car |
Part 2:
Now suppose that when you were just about to go out and buy your dream car, a friend walks into your house and tells you that he is in need of money. He asks you to lend Rs 8 lacs to him.
You feel confused and slightly sad. But you lend him that money. After all, what else are friends there for?
Five years later, that friend returns you the money, but without interest. Now you have got back your Rs 8 Lacs…but after 5 years.
So now you once again make up your mind to go and buy the car.
But which car can you buy with this amount? Can you buy what you had originally planned for?
I don’t think so…if you consider inflation.
So in simple words, you cannot buy Honda Amaze, as prices would have increased in last 5 years.
Probably you can still buy a smaller car – Honda Brio (prices would have risen to Rs 8 lacs in next 5 years)
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| Honda Brio – A Small Segment Car |
Part 3:
Now suppose that this friend returns your money – Rs 8 Lacs with interest.
Now which car can you buy with this amount?
Probably you can buy your original choice – Honda Amaze
Lets assume that inflation in car prices and interest percentage given by your friend are equal.
But wait a minute…
Your friend returning money to you, with interest is similar to a bank giving interest on your fixed deposit. Right?
And many people consider bank deposits as investments. Isn’t it?
But Warren Buffett said:
Investing is forgoing consumption nowin order to have the ability to consume more at a later date.
And I repeat, with emphasis:
Investing is forgoing consumption now in order to have the ability to consume more at a later date.
Key points in this quote by Buffett are:
- forgoing consumption now
- consume more at a later date
But as seen in Part 3, you are only able to buy a car (Amaze), which you were capable of buying even 5 years back.
So in a way, you are not capable of consumingmore in future when you put money in fixed deposits in banks. Even though you sacrificed buying it in present.
So what would you like to have if you forgo present day consumption to invest? If we go by the definition of investing given by Buffett, you should be able to buy more.
In this case, you should be able to buy a car bigger than Honda Amaze. Isn’t it?
May be you should be able to buy a Honda City, worth Rs 13 Lacs (in today’s price).
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| Honda City – An Upper Segment Car |
Or if you can wait more, say 7 years…then probably you should be able to buy an even bigger high-end luxury car like…. Honda CRV (today’s price Rs 22 Lacs).
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| Honda CR-V – A luxury SUV |
But putting your money in safe deposits will not increase its buying power. It will at most be a good option to preserve that buying power.
Only equities offer the potential of turning Rs 8 lacs to something more than Rs 13 lacs, which can help you buy a bigger car.
And that is the real power of investing in equities. You can improve your living standards and not just maintain your living standards.
Powerful thought. Think about it.
Note 1 – The car brand and models used in this example are only for illustrative purposes.
Note 2 – Please don’t think that I am promoting any high-end product, brand or AMC here. This example is primarily about how equities are better store of purchasing power than safer options like fixed deposits, etc.
True; and as a corollary, the next question is the mechanism on 'how' to decide the later date (with a near certainty of reaching the expected amount? – especially with equities (think volatility)). But in true WB sense, it is never 🙂
But then like everything in personal finance, it is an individual's choice (but being aware of whole gamut of such thoughts and corresponding tools) is the key..
Finest article I read in long time which answers WHY to invest. The examples wrote in terms of which car to buy is sure going to make every reader easier to understand the crux of the article. I just want to add one thing: Yes, Warren Buffet didn't do any financial planning (from so called certified financial planners). Well, I mean, he did planning but not the way the current generation does. He did it with his common sense he learnt from his teacher Ben Graham. I want to say again, this is really the finest and simplest yet most powerful article I read in long times. I'm going to share this too.
Dev,
I practice what is said in this article religiously. I try and live frugal living as far as possible.
As an example, Even though I could afford easily a IPhone, considering my usage a good Android phone is sufficient today and for the near future. So when I decided for a new phone I bought a high end lenevo and invested the rest in a good fund to enable me to buy at least the same or even a I phone say after 3 to 5 years when I will again buy a new phone. I have followed this in the past in many of my purchases and have felt the success.
But when I suggested it to a new generation youngster, the reply was I want to enjoy today and who cares about 5years and may be with a better salary will buy a better phone that time again.
The question here is all may be without doing any planning for it and ended buying same IPhone without having a need for it.
As a point, I always invest at least 20% of the biggest purchase in to funds to cater future repeated purchase of the same item.
Thanks Sreekanth 🙂 Glad you liked it.
And I completely agree with you that even though Buffett [supposedly] did not believe in personal financial planning as we know of it today, he still would have all his safety nets in place.
And just to share a fun fact, I read it recently that Buffett was fully capable of retiring at the young age of 26 years, if he wanted to. He had the corpus to do it. So now we know why he did not need the so-called personal financial planning 🙂
Agreed Anand. Its tough to predict the 'End-Date' when dealing with a volatile asset class like equities.
But this indirectly points at something very important. If you need some money in short term, you should never depend on your stock market investments. But if the target is far into the future, there is no better option than equities.
Thanks for sharing your personal experiences Ajay.
And I really liked the concept of parking X% of money, required to buy things which have to be purchased every few years. This in reality creates a small base to fund future expenses of similar nature. Very useful tip!!
Hi Dev,
As usual nice short and thought provoking article. I have read a little about Buffett though not a great deal and two things i am not able to co-relate, hope you would throw some light on it. Firstly he talks about economic moats, competitive advantage, buying companies with great businesses etc., but these companies rarely come cheap (or they may do say like 2008, but unfortunately liquid cash may not be available during those times). The stocks most of times trades above the intrinsic values. How does these concept of moats and buying cheap with margin of safety go together.Is it fine paying a bit of a premium of solid companies?