Temperament is crucial

In the area of investing, temperament is more important than IQ.  As per Warren Buffet, succesful investing does not correlate with IQ. Once you have some basic intelligence, what seperates a good investor from a bad one is the ability to stay calm during the ups and downs of the market. Successful long-term investors have the ability to keep calm and remain unpeturbed when the investment environment around them turns volatile. 

A good or a bad temperament can be reflected in several ways and behaviours.  The foremost is the ability to not get impacted by either sharp changes in the market or the narratives that get built around the changes. This becomes even more important in modern times due to social media and due to the speed at which news and information moves around the world. One's patience with the process despite the volatility is very important. Successful investing often requires holding onto assets for the long term, despite the short-term fluctuations. Impatient investors often make poor decisions based on emotional urges to take decisions. Read my post about staying the course here.  Investing is a marathon, not a short sprint. 

Debt - A good or bad idea

This is another one of those very contentious topics that gets a lot of extreme opinions.  So is debt a good or a bad idea?  And like many other subjects in personal finance; it depends!

Debt comes in many forms.  The most simple kind of debt could be a small amount borrowed from a friend or a family member. Another type and probably the more common type is credit card debt. And then the larger debt like a loan to buy a car or a mortgage to buy a house. So which of these could possibly be good debt?  Well, it depends. My personal preference is to separate debt into 2 kinds; debt that is used merely for consumption and that used to purchase a depreciating asset and on the other hand debt used for a productive purpose or to purchase an appreciating asset.

First of all, all debt needs to be repaid at some point and comes with a cost. So the first and probably the most important consideration is whether you can afford it.  Very often, the start of a serious financial crisis starts with a loan that one can't afford to pay back.  And hence it is important that you have confirmed that you can afford to pay back the loan including the interest. Very often there are variable components to the loan, eg the interest rate.  As time passes the interest rates may increase thus increasing your monthly payments. Moreover, you need to assess the risk to your income that helps you to pay back the loan.  Is there a reasonable risk that you will not be able to pay back the monthly instalments in the future? 

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An important consideration is the financial impact of the asset that you are buying. Are you taking on debt to pay for a holiday? Or to buy a depreciating asset like a car.  Remember it may feel exciting to go on a holiday using borrowed money but as soon as the holiday is over in a few days, you will be left with the burden of paying off the loan over a period of time. Pleasure for a few days and financial burden for a few years. Will this be worthwhile? Also understand that the value of car will depreciate the moment it leaves the showroom.  And it will continue to lose value over time while you continue to bear the burden of the debt for many years. In other words, these are examples of non productive debt and I advice people to refrain from taking on such debt.

On the other hand there is productive debt.  Debt that allows you to produce more or create an asset in the future. A good example is a mortgage.  A mortgage allows you to build an asset over time, something that appreciates in value over time. Although a mortgage is as risky as any other debt in terms of risk of affordability, if used wisely, it can help you to build a asset over time and hence I call it good debt as long as you use it wisely. Make sure that the monthly exposure that you have in terms of monthly repayment is set in such a way that you can still afford to pay the EMI even if the rate of interest changes over time. Have enough buffer to account for unforeseen increases in the interest rates.  Then again, should you buy a house or rent it?  Read my post here to know more.

The worst kind of debt is credit card debt which should be avoided at all costs. The interest costs associated with credit card debt are exorbitant and the cost can spiral up very quickly if not managed carefully.

In summary, debt can be good or bad depending on how you use it. Any questions? Post your query in the comments section below.

Trust the capitalists

Remember the doomsday feeling of 2008? Or the panic of March 2020? And in between there have been several instances of the market dropping by 10% or more over a short period.  And each time everyone has felt panic.  That feeling of absolute nervousness.  As if the end is near. 

And in every one of those cases, the markets recovered to make new highs!.  Remember this. The next time the market drops quickly and by a large value, trust the capitalists.  They will continue to build value in the market.  And every one of those drops will be followed by a recovery and a new high.

If you look back into history, you will see this happen over and over again.  A quick glance at the 20 year trend of the Nifty 50 will only confirm this.  That markets have dropped sharply in the past, always to recover and go on to make new highs. Remember October 2005?  The Nifty took a sharp drop from 2644 in early Oct to go down to 2316 by  the end of the month. But the recovery took less than 30 days.  The Nifty 50 moved from a low of 2316 on 28th Oct to trace back to 2664 on 25th Nov 2005. Take a look at Myy 2006. After hovering around the 3754 mark  in early May, the market dropped quickly to 2632 by the middle of June, almost 30% lower.  Then again, the market went on to recover to 3769 by the end of Oct, taking a little while longer. Trust the capitalists!

While the above examples may not be in many people's memories, I am sure the events of 2008 and 2020 will be.  Even the investors who have begun the journey recently will remember the big one of 2020. The panic of COVID-19 was jsut setting in. The sense of an upcoming global pandemic was being felt by the market. I remember watching the news closely as businesses started shutting operations. And then the Nifty 50 took a sharp nosedive. From 12,201 in the middle of February 2020, the market collapsed quickly to reach a low of 7610 within a month on 23rd March.  That amounts a sharp nosedive of about 38%!! Several people were predicting the end of the markets.  Emotions were running high as some even pointed to a very long period of pain. At that point and in the following days, many distraught investors fled the marekt. Some making huge losses as the chaos continued for a few weeks.

 And as I have said several times in this blog, trust the capitalists. Despite the doom and gloom of the pandemic, the market recovered back to the 12,200 mark by early November of 2020. It is not just the recovery that begs attention. It is the strength of the recovery and the momentum thereafter!

It is importatnt that I mention an important consideration. The market will always rise. That does not mean every company will. The markets and investors are vicious.  They celebrate the performers and severely punish the laggards.  And hence every few years, some companies will die, while some others will zoom to the top.  What matters is that you have a broad portfolio that is balanced.  Invest into broad and diversified funds. Have some allocation to broad index funds. It is difficult to pin point which company will be a winner. But not too difficult to point to the fact that the broader markets will continue to rise after every fall. You only got to make sure that you stay the course. 

So as we reflect upon the slight nervousness in the market over the recent moves of the Nifty 50, remember this.  Trust the capitalists.  

The importance of discipline in investing

 Almost everybody I know has alll the information regarding the importance of a healthy diet. But almost all find it difficicult to follow it. The same with investing. And just like the a good healthy diet, one can experience the benefits of investing only if one maintains the strategy for the long term. Markets will rise and markets will fall. And often markets will move sideways for a long time. The key to a successful investing outcome depends on how one reacts to the markets over time.  The secret to success?  Do nothing. 

It is important that ones first sets out the goal and the path to it.  This would involve calculating the end goal of an investment process over time. This should consider the current cost of living, inflation, changes in lifestyle etc. And aside from the final goal, one needs to consider and sign off on the path.  How do you want to go about your investment process? There are several approaches and all could be useful depending on your own style and risk appetite. You can explore the various options in other parts of this blog.If you have a long investment timescale and can afford to sustain some ups and downs, you can probably take a significant amount of risk. If you need the money in 5-10 years and don’t have any other assets, a more cautious approach is required. Read about asset allocation here

Once you have set up the process, stick to it. Many times short term market fluctuations can lead you to doubt your decisions.  Don't let emotions interfere in your investment process. A sharp fall in the market can be stressful, and many investors may sell in panic. But a dip is usually followed by a recovery, and this can happen very quickly. Taking money out means missing out on this recovery. But more importantly, long-term returns are not based on a straight line. The drop and subsequent recovery are not a short-term anomaly that we need to allow to pass – they are a key feature of how the market functions. Remember that every drop in the market in the past has been followed by a recovery.

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Holding a balanced portfolio over a long period of time and adjusting the allocation over time as your risk profile changes is key to a successful investment process. Discipline matters!

The value of 1%

I am often surprised at the casual approach of many people to a small difference in return on investments. How do people react to say a return of 11% per annum compared to a return of 12% per annum.

Most people will not see a large difference and some may respond with a shrug of the shoulders. This is because in absolute terms, it is difficult to comprehend the impact of the 1% difference in return. This is because we are not able to visualize or see the impact over time very easily.

To understand the real impact of the 1%, let us use a simple illustration. Let us assume that an investor has a capital of INR 10,000 to invest. Let us make another important assumption. The investment lifetime of any young person is about 35 years. What will be the final result of this 10,000 invested at 11% over the period of 35 years. Compounded annually at 11%, this small amount of 10,000 will grow to an interesting 3,85,748 over the period of 35 years. While this looks impressive, what will be the final outcome me if the rate of return was just 1% at 12%?

10,000 invested at a rate of return of 12% over a 35 years period will grow to a whopping 5,27,996!!

That is a large difference of 1,42,000 or 37% more money at the end of 35 years. Now that you can see the difference between the final result of investing at 11% or 12%, would you look at the 1% difference the same way?

Interesting right?

Have you been a victim of such thinking in the past? Let me know in the comments below.

Don't be stupid

Don't be stupid, you know I love you

Don't be ridiculous, you know I need you

Don't be absurd, you know I want you

Don't be impossible

The famous lyrics from Shania Twain's hit song are also relevant to the world of investing. Don't be stupid.

It I said that doing badly in the investing process can be as equally difficult as doing very well; as long as one sticks to the basic principles and one does not do anything stupid. Often, managing risk is key to getting the job done. Lack of success in the world of investing has less to do with taking great decisions and more to do with just avoiding stupid stuff. Avoid too much risk and success will follow.

So what are the stupid things that one needs to avoid?

For starters, temper your expectations. Although this is not a decision itself, how one sets expectations has a strong impact on the decisions one will take. If your expectations are within limits, you will tend to take less of stupid decisions that are driven by over expectation and hence disappointments related to the actual performance of your investments. Don't get swayed by what you read on social media. 25% CAGR is not really necessary to succeed. As long as one is achieving 5% to 6% over average inflation, you are already on the path to success. Hence keep your expectations within reasonable limits. 

Maintain a balanced portfolio. Having assets across multiple asset classes will ensure that you ride the cyclical waves of each asset class. There is no need to take unnecessary risk and allocate a disproportionate share to any one asset class based on recent performance. Remember, everything reverts to the mean eventually.

Save and invest aggressively. There is no substitute for this. Consistent investing and holding the investments over a long period of time is a critical element to success. There is no quick magic. And if you read about how other  people are getting rich quickly, run away from such stuff. Stay consistent.

Anything else that you suggest? Mention your suggestion in the comments below

CAGR v/s IRR

Of course!  The most important measure of success as an invester is the rate of return. But what exactly does this mean? And how is it calculated?

There is no greater pleasure than to flaunt your rate of return. Assuming that it is something to be proud of. But more impoertatly, it is important that one is aware of the rate of return so that one can judge the success of the investment process. So how does one measure the rate of return of an investment? Often, many people use absolute return as a measure. Nothing can be as risky as using absolute returns of an investment. Absolute returns refer to the increase in the value of an investment without considering for how long the money has remained investment. So what is the right way to measure the rate of return?

CAGR and IRR are commonly used methods to measure the rate of return.

As the acronym suggests, the compounded annual growth rate (CAGR) indicates the compounded rate of return of an investment on an annual basis, considering the value of the investment at the start and the end of the period. CAGR is commonly used as a measure across several areas of business including to show the growth of a business or sales.  However, the validity of CAGR is limited to calculating the growth rate of an investment between a fixed start and end date. It is not a good indicator when investments are made at multiple points of time. This is where IRR comes in very useful. 

The calculation of CAGR is relatively straight forward. It can 3 inputs; the start value of an investment, the end value of an investment and the period for which the money remained invested.  While the CAGR calculation is an excellent indicator of returns, it becomes limited in use when the investments are made at multiple time periods eg. investments made via an SIP on a monthly basis. IRR is more flexible as it considers multiple cash flows and time periods. 

That begs the question. Which one is a better measure to understand the performance of an investment. Neither is categorically better. IRR is a better measure when investments are made at multiple points over time while CAGR is better suited while measuring the performacne of a lumpsum amount over a period of time.