May 12, 2016

Chasing returns is not about the money

Let me share the story a young guy who has just graduated. He recently got a nice job with a company and is able to save around 2 lacs per annum after all his expenses.
Now this guy is quite similar to all his peers, but different from his hot blooded brethren only on one small point. He believes in saving and investing, but does not want to chase stock market returns. In the last few years, he read a few books on investing by john bogle, and decided that he was going to invest in some decent mutual or index fund and then leave it at that.

You see, this young guy has a girlfriend and wants to spend time with her. In addition, he also wants to use his spare time pursuing hobbies like painting and travelling.
He sets up a simple plan:
-           Save 2 lacs per year and invest it in a few index/ mutual funds
-           Increase his savings by 5% every year to match inflation
-           Invest each month via an SIP to put it on autopilot
-           Avoid financial news on TV and use the spare time on other pursuits

Ten years later this guy who is now married, decides to have a look at his investment account. During this period, the overall market has delivered around 15% per annum for the last 10 years. He finds that his account is now around 67 Lacs. Not bad!

He goes back to his usual life and forgets about this whole stock market thing. The only time he checks is to extend the SIP in his account as most banks don’t provide a 10 year SIP option
Its twenty years now since he started and one day his wife asks him if they have decent savings which can be tapped for their daughter’s education, 10 years from now.

He goes back to his account and is pleasantly surprised to find that the account now has 3.7 Crs. He is confidently able to tell his wife that they truly afford a good quality education for their children.
At the age of 55, its time finally to fund their daughter’s education. Our guy, who is no longer as young, decides to look at his account and finds that the account has 16 crores!! This is far more than he ever imagined. Both he and his wife now start thinking of taking an early retirement. They figure that in 5 years’ time, the account would grow to around 29 Crs ** at the current rate if they can fund their daughter’s education from the liquid cash they have been holding on the side. This amount would be sufficient to retire and lead a comfortable life

Now I know some of you would raise objections like
-           15% consistent returns are good in theory, but the actual returns are more lumpy.
-           Not everyone can save 2 lacs or do that without fail every year

Let me handle them both -
If you save consistently and do not withdraw the capital from the account, a smooth or lump 15% would still amount to the same in the end. It is only when people act smart and try to time in and out of market (and change the amount invested), that the eventual amount depends on the pattern of returns.

In addition, our overall stock market has delivered around 12-13% return in the last 20 years and if you add dividend and the effect of monthly cost averaging, a 15% CAGR is quite reasonable
On the second point, 2 lac saving per annum may not be possible for everyone, but I am sure a lot of two income professionals can muster this level of savings. In addition, I have assumed that the contribution rises only at 5% per annum. In most cases, earnings and hence savings can rise faster than that.

So my point is this – If the objective is to meet your personal financial goals, then discipline in saving and investing consistently is far more important than chasing the next hot sector or hot stock. Ocourse, higher returns will get you to your goals faster, but beyond a level of wealth, it more about flaunting than about its utility.
However, If the reason for chasing returns in the market is to get on TV or twitter to show the world how smart you are, then we are talking of a completely different objective. In such a case, the actual returns have nothing to do with the money or financial goals.

** If you wondering about the impact of inflation , a 6% inflation would still mean a nest egg of around 3.8 Crs in current money terms. In my books, even this is a good amount of money
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.


Shan said...

And what if he has a similar friend who withdraws after 5 years to go for higher studies at an expensive US university and now has 10cr at the age of 35. Painting a long term picture like this is being trapped in a job. Remember the first investment is in yourself. Making retirement plans at the age of 35 is merely exposing yourself to black swan events. You can't and shouldn't generalise these things. Over such long periods of time you run the risk of wars (multiple times since independence) excessively high taxes and inflation (many times since independence), being fired from the job, and your own health and family's health.
Instead the better advice is to invest in yourself first. Maximise your income by all legal means. Save a Portion of it for long term only after you are convinced you are making above average salary. If you are not, then reinvest the savings in increasing your income. Else you'll always be stuck in a subpar job while your peers race away achieving their maximum potential and end up employing and firing you at will.

Lucky said...

Very relevant article: small and simple is always beautiful. However, the assumptions are not always correct. I have clocked 13.88% as of today in a combination of SIPs (in a few best quality funds) started in Dec-2005. Expecting 12% from index funds sounds more reasonable.
Investing 2 lakh a year can be very misleading. It's good for someone who is earning e.g. 5-6 lakh but not for someone who is making substantially more or less. Assuming {return from investment == inflation == salary hike == increase in savings}, if one needs to save 30-35 times annual expenses for retirement, then one needs to limit the expenses to half the salary and save the other half and keep doing it for 30-35 years. Suitable adjustments can be made based on change in expectations but this is the baseline one must start with.

Rohit Chauhan said...

hi shan
you are missing the point here. I am not talking of solving all of life's problems by being a regular investor and saver. I am not sharing the secret of being successful and achieving your full potential in a small post.
irrespective of what path you take, the point of saving and investing always hold true.
ofcourse if you earn a million dollars and save a good portion of it, then these rules may not apply. but we are talking of 1% of the normal population in that case

Rohit Chauhan said...

Hi lucky
sure that's the point I made in the post. the numbers will vary, but being a consistent saver and investor usually works will it be otherwise ?


Vinayak Gavankar said...

Hi Rohit

I am a great fan of yours & have got immensely benefitted in the past. This article again has proved that if you follow the 'KISS' (Keep it simple stupid) principle life can really be simple. I have a question though not directly related to this article, I believe you can help me. The question is as follows:

I read somewhere that Mohnish Pabrai runs a fund in which he doesn't charge any fees if his fund generates a return of 6% or less ( or what can be safely earned by investing in treasury bonds )& only when the return exceeds that level then only his charges will come into picture. My question is this true ? & if yes do we have any such fund managers/People in India where small investors can invest safely ?
Thanks .

vinbat007 said...

Hi Rohit.Great post.I have understood the basic idea of the article.Still I am not able to reach to the figure of 67 lacs and then 3.7 cr with the assumptions you took.Can you please illustrate the calculation?I am just curious.

Rohit Chauhan said...

Hi vinayak
I am aware of such managers ..I think looking at the RIA database of sebi should help. but that runs into hundereds best option is to get leads from people who are invested with such managers and have had a decent experience with them


Rohit Chauhan said...

basically the investor continues to invests 2 lacs per year, adjusted for 5% inflation and compound the year end number with a return of 15%. that will turn 67 lacs to 3.7 crs. offcourse this is just for illustration reality returns are never smooth



While the article does talk about discipline, but it captures an ideal life of a young man, planning also consist of many other factors like medical expenses, buying house or taking care of elderly parents job's top perfect to be real case