Buy or rent?

 I am sure this is a very emotive subject. The perennial debate over buying versus renting a home evokes profound passions. I have come across very extreme positions on this subject and I am sure we will continue to see some very strong opinions depending on which side of the argument you sit. Choosing to either buy or rent has a big impact on your financial health, lifestyle and personal goals. 

Let us commence with the allure of homeownership. It is general common wisdom that buying a house is a good investment. Undeniably, the merits abound. Owning a house is an Indian religion and a dream for most families. But often the emotive side of owning a house is passed off under the garb of a sound financial decision. Don't get me wrong. There are a lot of strong advantages in owning a house. First of all it has huge social value within the community. One gets a perceived higher status within the community as a home owner.  It also provides an anchor, the opportunity to completely renovate and customize one's den. It takes away the hassle of constantly moving in case the landlord doesn't want to extend the contract. Moving house frequently also impacts the children; having to move away from their close friends and always needing to make new friends. 

But purely from a financial perspective, how does the money invested in a house stack up against other investment options? 

A decision to buy a house have several advantages. Aside from some of the points mentioned above there a few financial points that need to be considered. With modern day mortgage facilities, buying a house gives an option to slowly build equity. This works specially well for people who don't have an inherent discipline to save and invest; it forces an obligation to allocate money to the mortgage thus forcing one to save/invest. It forces you to make the monthly mortgage payment thus slowly building equity. Hence for people who do not have the discipline to save/invest, buying a house works as a proxy for long term savings. But I guess this is where the benefits kind of stop.

First of all, buying a house is a huge anchor. In many ways, it anchors you to the city and locality. In today's mobile world is this something you would like to tie yourself down to? This anchor will eventually shape your decisions around mobility and taking up new career opportunities should they arise. This holds specially true in the early years of your career as you maneuvre around and try to climb the organization hierarchy.

But the most important perspective will be in terms of the trade offs. Would you be better off persueing other investment options for a better return and accelerate the wealth building process in the initial years? With the level of monthly saving / investment remaining the same, the initial rate of return in the early years have a huge multiplier impact on the final outcome. Hence it would be prudent to compare the estimated returns say from mutual funds versus the net rate of return from an investment in property. Needless to say the net rate of return will vary from city to city although the difference may not be significant across most places. I refer to the net rate of return  as one needs to account for the cost of a mortgage, taxes, the initial transaction costs etc. 

Based on my experience and looking at the calculation mentioned above, I recommend renting a house in the early years and diverting your funds to equity related investments. As I have written here, building that initial base fund is extremely important and hence the initial years are best used to build that based fund. However this only works if you have the discipline to regularly invest and work actively to build the initial base fund. As I have mentioned above, if you don't have the discipline you may be better off taking the plunge and paying month EMI as a proxy for building your initial base fund. Remember that buying a house comes with a lot of long term responsibility and takes away a fair amount of flexibility in your decisions. Moreover, instead of paying the EMI (which includes a significant amount of interest cost in the initial years), the initial years can be better untilized to invest aggressively into an asset class like equity or mutual funds, thus getting a head start in building your wealth. 

Time is your friend

Very often the focus of any investor is on the returns and the choice of asset class. How often have we had a coffee machine chat with our colleague at the office about the fantastic new investment deal he did. The most often chatter is usually about the next multi bagger stock that has been identified. While the chatter around the stupendous profits from cryptos have died down in recent times, I am sure you would have been inundated with talks of the big profits that everyone earned.

While the choice of asset class and finding the multi baggers is important, an oft neglected factor is the time. Time is an important factor and nay I say an extremely important factor in the investment journey. It takes little intelligence or skill. And yet it is the one that most of us miss out on.

How many of us can confidently say that we made the best use of our investment opportunities in our twenties? Did you maximize your savings and investments when you were in your twenties? Just a handful will be able to say so. Most of us miss out on our best years; the early years of our productive life. 

10,000 invested at an age of 25 is significantly more powerful than the 10,000 invested at the age of 35. I will illustrate this with an example below. 

The simplest trick in the book is to invest aggressively in the early years and then sit tight for as long as required. You can watch my video about the Magic of Compounding here.

In order to understand the power of time, lets look at the illustration below. Now in order to understand the illustration we need to make a few assumptions. These are just assumptions and you can use your own assumptions and rebuild the illustration. But whichever way you look at it, the inference will be the same. That TIME is an extremely important factor in the investment process.

Let us assume the investment journey of 2 young people. Let us call them Jim and Jane. 

Jim is a carefree soul. Always out to have a good time. He lives the high life in his early years. He doesn't have any savings and hence does not begin his investment journey until he turns 35. He begins investing at the age of 35 and continues investing monthly investments until he turns 60.

On the other hand, Jane is a lot focused on her savings and investments. She starts saving and investing her income as soon as she starts working at the age of 25. In other words she invests for 36 years until she turns 60.

In order to keep this calculation let us assume that each of them invests 1,000 per month during their investment process and both earn the same annual return of 12% pa. Of course these are plain assumptions and you can use your own. 

If each of them invests 1000 per month and earns 12% per month, the below is the final output at the ends of their respective investment period. For the sake of simplicity, the below illustration assumes that the monthly investments are made in a lump-sum amount at the beginning of each year and that the return is compounded on an annual basis.

Now I understand you will already have many questions! Very valid ones. Wouldn't they be able to increase their monthly investments as they progress in their career? Is the rate of assumed rate of return as fair one? 

As I mentioned the the illustration is based on simple assumptions. You may use different ones. But without fail the outcome will show you that the person who begins investing early ends up in a much stronger position at the end of the investment process. 

So who would you want to be? Jim or Jane.  Comment below and let me know your thoughts. 

Size Matters

 This is something I heard from a former line manager almost a decade ago

 "100% of nothing is still nothing"

 At the time I was working in sales a lot of our business review meetings used to track percentage growth. It was in this context that he had mentioned those those wise words. Size does matter. 

 Which is why in the investment process building that initial corpus is so critical. We often get bogged down by conversations around percentage returns and constant investment activity. This may involve constantly churning the portfolio by trying to chase higher returns. And herein lies the problem. How many times have you heard a friend or an office colleague wax eloquent about a recent investment they made only to find out that they own a mere 10 or 20 shares? While I understand that we all need to start somewhere, these shares will do little or nothing even if the returns are significantly high. In other words a high return against a small investment will still be small. 

 The initial years need to be focused on building the base. Save aggressively even to the point of depriving yourself of some luxuries. Remember the magic of compounding starts looking very interesting only once you have built a certain base value of your portfolio. A 10% return on 1 crore equates 10,00,000 while a 20% return on a portfolio of 1,00,000 he's a mere 20,000.

 Hence as you begin your investment journey remain focused on building the size of your portfolio. Once you have built a reasonable size even an average return will be substantial. But to get there your focus in the initial years needs to be on extreme savings and investment. Once you have built your initial capital there is no looking back.

How not to invest. Click here

Buy the haystack

"Buying the haystack" is a simple way to say you should invest in everything instead of trying to pick winners. The term was made famous by the legendary Jack Bogle who pioneered the idea of index funds. 

Now imagine you live in a village with 10 business. Each business either sells groceries or hardware or provides a service like a laundry or a hair cutting saloon. If you had the option to invest some money into the businesses which one would you chose? Here comes the complex part. How accurately would you know which of the businesses would do well over the next 10 - 20 years? What if another laundry opened next door leading to the original one shutting shop. What if the family running the hardware store starts to lose interest in the business and  starts to lose money? Selecting the right business from among the various existing business is a tough one. It is a very complex one. And most often even the brightest tend to go wrong. 

What if you could buy all 10 businesses in the village?  That takes away the risk of any one of the businesses we invested in going under. Needless to stay, the population of the village and the demand for goods and services will continue to grow. In other words, the total value of the business in the village will continue to grow. Hence investing in all the businesses in the village gives you the opportunity to get a pie of the share without the risk of selecting one or more specific businesses. 

CLICK HERE

That brings us to Index funds. An INDEX FUND is a type of a mutual funds that invests across the entire market or an entire segment of the market. It takes away the investing biases of an individual. Investing in index funds has long been considered one of the smartest investment moves you can make. Index funds are affordable, enable diversification, and tend to generate attractive returns over a longer period of  time.

As mentioned above, the biggest benefit of an index fund is the elimination of personal bias. It takes away the complexity of selecting specific companies to invest in and rides the general growth of all business within the index. In other words, the fund invests your money into all the companies in that index based on the weightage that each company holds in the index. It is assumed that fund managers who manage mutual funds are smart enough to know which companies to invest in and which ones to avoid. However historical data suggests that over a long period of 10 years or more, there is little to chose. Very few active funds will have beaten the index. While some active funds will beat the index, the question is which ones? 

Another important reason to invest in an Index fund is the diversification it provides across various industries, companies and business cycles. Remember that an index itself is a self correcting one. Over the period, poorly performing companies will be eliminated from the index while well performing companies get added. This provides a vast diversification of the fund.

The most important advantage of an index fund is the low cost. Investing in an actively managed mutual may entail an annual cost of 1% to 2% which is taken from your investment fund. In other words, the fund house will deduct that amount each year from your fund. This is referred to as the Total Expense Ratio (TER). Now imagine the impact of this on your investment compared to the TER of an index fund which may vary form 0.15% to 0.3%. This has a huge impact on the total outcome say at the end of 15 or 20 years.

Size Matters    Click here

 In summary, index funds are an excellent route to building wealth over the long term. Could other active funds beat the index funds? Sure. A few will. Alas if only we have that crystal ball to know which ones!

 Need to talk about Index Funds? Leave a comment below. 

Stay the course

 By now you would have guessed that I am huge fan of equity investing as a route to creating immense wealth. As much as it a very simple process, most fail to achieve this goal on account of a simple issue; shortsightedness.

Human psychology plays a HUGE role in the process and one needs more of a good temperament and not necessarily a high IQ. The ability to ride the waves and have a long term view of the process is critical. And often most investors fail in this area. 

In the times of instant noodles and instant photos, patience has been a big victim. Investors cannot control the urge to get ahead of themselves and start feeling impatient about the investing process. We expect quick returns. We expect the outcomes immediately. Unfortunately investing in equity is a slow but sure path to wealth. But only we if we have the patience to stay the course. Set out a 15 years plan once you start your investment journey. Remain focused on the process and methodology. Maximize your investments as much as possible and do not stress yourself about the returns. Shortsightedness often makes us lose steam and abandon the process. Remain patient. 

While you are here you may want to check out my video about Retirement Planning

Another reason why many investors fail to build wealth is their inability to ride the short term volatility. Market are volatile in the short term. Often very volatile. But history has shown us that the market keep rising in the long term. But many investors tend to abandon ship and end their journey due to short term loses that they experience when markets turn volatile and drop sharply. Markets dropping sharply is in fact a golden opportunity to add more to the portfolio. Imagine panicking when the store next door announces a huge sale on TVs or washing machines. Isn't it a big opportunity to make that purchase? In other words, market dropping sharply is a great opportunity to add most to your portfolio at discounted prices. But most importantly, if you cannot make additional investments, hang in there. Every bear market has been followed by a bull market. Stay the course.

If you continue unfazed despite the ups and downs of the market, you are very likely to generate huge wealth over the longer period if you stay the course. Investing is a marathon. Not a 100 meters race!

Asset Allocation

What exactly is asset allocation and why is it important?

In simple terms, it is a strategy to balance risk and reward of your investments. It is like selecting your cricket team. In a game of cricket, would you selected 3 batsmen and 5 bowlers? Or would you refer more all-rounders? Asset allocation is all about structuring your various investments in a way that fits into your investment objective. How much risk are you willing to take?  And what returns are you trying to achieve?

The most important part of an asset allocation strategy is risk management. It is important that you secure yourself from risk as a starting point. Risk can be different types. A significant risk is about losing your capital. But a very important and often unseen risk is that of inflation. If your asset is not beating inflation that your assets will continue to be worth less every year.

 First of all, what are the key considerations when you design your portfolio? Every asset class is different with its own unique features. While working on your asset allocation, the first thing to consider is the risk and return ratio. How risky is the asset? And what are the expected returns? While most people tend to see risk and return easily, often we lose sight of things like liquidity? How quickly can you convert the asset into cash in case you need to? As an example, an investment in shares or mutual funds can be easily converted into cash within 3 – 4 days. Whereas an asset like land may take a few months or years to convert into cash.

 Another consideration is the active management required to manage the asset. As an example, if you own a flat which you rent out, there is a certain amount of active management required. This may include repairs, periodic signing of leave and license agreement etc.

One other thing is physical management of an asset like gold. I am personally not a big fan of physical gold. Because it comes with a lot of hassles to handle it and keep it safe.

Let’s begin by looking at various asset classes. 

Fixed Deposits: The most popular one is India is fixed deposits with a bank.  These types of assets are usually relatively low risk but also give a relatively low return. Note that I mentioned relatively low risk. Remember that there is no asset class that is completely risk free. Some may have high risk and others low risk.  Fixed deposits are very popular in India due to several reasons. First of all, most people seem to understand the asset class. Another important reason is that a fixed deposit can be purchased at the local bank. Most likely the branch manager will approach you to start a bank deposit. And the most important reason is the fixed return. This I think is the most appealing reason for a fixed deposit being the asset of choice. However it is not the first option for me. Fixed deposits have merits. Limited merits. On the positive side, FDs are easy to understand and provide a fixed rate of return. Unfortunately the return is low and often same as or slightly above inflation. This issue coupled with the tax impact make a FD my least favorite asset class. Remember that FDs are taxed at the same rate ads your regular income. 

Property: Historically property have been a popular asset class. Property can be further divided into 2 categories; land or plots of land or rental property. In a highly accelerating rate of urbanization, property has proven to be a good asset class in the past. Specially rental property given the relatively fair appreciation in value in the past and also the benefit of periodic cash flow in the form of rent. On the flip side, property required active management. Often land suffers from issue of encroachment and several other complexities. In the case of rental properties, a lot of active work is required in the form of maintenance, documentation and the sometimes a cranky tenant.  Finally remember that property is not a liquid asset class. It is not easy to convert the property into cash at short notice. It is a rather a long and complex process to liquidate a property.

Gold:  Gold has been and is a very popular asset class. Families have past on gold through the generations with each generation adding to the kitty. Most often the investment is in physical gold in the form of ornaments although some may include gold bullion. And while gold remains a popular investment option, this is definitely not among my favourites. Specially given my experience with gold!  In the past I have held gold bullion but I found it is a hassle to manage aside from relatively lower returns. Given my several moves across cities in the past, moving the gold was one of my biggest headaches. Gold requires a lot of physical management. Moreover, it is not easy to liquidate contrary to popular opinion. 

Equity: Equity is by far my favourite asset class.  I am a huge fan of this asset class given its past performance and several other features discussed below. First of all equity is known to beat inflation over the long term and this is the most important reason for my soft spot for this asset class. Remember than inflation can slowly eat into the value of your assets and hence it is extremely important that the return beats inflation. Often people refer to investments in equity as gambling. This is why I say this asset class is vert misunderstood. I think the relative volatility of investments in equity give people the impression of a casino. However it can be proven and back tested that investments in equity are far more rewarding that most other asset classes. Investments in equity can be further classified into 2 broad categories:

Direct equity: One route to investing in equity is to invest in shares of companies. In this process you buy shares of certain companies and become a part owner of these companies. This however comes with the risk of not knowing which companies to invest in. Sometimes companies that you invest in may suffer from poor performance and lose value. Hence this is an area that is best left to the experts although one may allocate a small portion and learn the intricacies along the way.

Mutual Funds: Another route to investing in equity is via mutual funds. A mutual fund is a common pool where multiple investors pool their money and an 'expert' fund manager invests in the various companies on your behalf. This partly takes away the risk of investing in bad companies since the choice of the companies is left to the fund manager (a fund manager may also make poor decisions). 

So what is the best asset allocation? There is none.

Each investor is unique and has unique circumstances. Hence every individual investor is different and have different needs. It is important that you review your own circumstances and needs and design something that works for you.  There are several thumb rules for this.

An important approach is age based. At a young age, allocate more to equity and less to fixed deposits or debt funds. This is one account of the long road ahead for active income which provides enough time for you to ride out the volatility while the magic of compounding kicks in.  As one moves to middle age or closer to retirement, it would be prudent to lower the exposure to equity and hence lower exposure to volatility.   Read my detailed post about this methodology here.

Would you like to have a chat about your asset allocation strategy? Email me at firstlifeskillz@gmail.com  Remember I am just an amateur and I don't sell anything. I am not remotely affiliated to any company that sells financial products. 

Retirement Planning

 Retirement planning is probably the most contentious subject based on a few discussions I have had in the past. I find that people usually have extreme views about retirement planning. 

Retirement planning is like the HUGE ship in the horizon. It appears almost static in the horizon. A  small spec in the distance. It doesn't seem to move. It is as if it is stationary. And yet it is moving towards you. It's moving at high speed but you don't seem to notice it coming. And while you get busy with life, you tend to forget about it until it appears into sight. A huge, gigantic ship. Unfortunately and like most of us we are often caught on the wrong foot. Not having done enough to secure our retired life. 

Active income will stop at some point in your life. But expenses will not. And hence it is critical that one plans for retirement as early as possible. As early as your 20's, when retirement feels like that huge ship in the horizon.

In the good old days, many organizations and govt offices provided the safety net of a pension. Alas aside from private organizations, even governments have started scaling back on pension with some state governments doing away with it completely.  In order words, you are on your own!!

In the past, parents used to depend on their children to fund their retirement. In the golden years, children would usually take care of the parents; for all needs including financial needs. This too is now facing a huge change. With nuclear families in fashion and geographic mobility more common, it is turning out to be  a though situation for the older folks. 

So have you started planning for your retirement yet? Why do you need to plan?

As mentioned earlier, your active income (earned by giving away your time and working) will stop at some time in the future when you retire. Assuming you retire at the age of 60 years, you will still need to fund another 20 - 30 year ahead based on your saving. Hence it is important that you start your planning right away. Retirement planning is easy and yet very complex for the following reasons:

Living longer: We are living longer. Much longer than the previous generations. with increasing life expectancy, we now need to fund a much longer retirement period. Unlike the past, our retirement could last for 20 or even 30 years. And hence planning the funds for retirement becomes a complex affair. 

Inflation: What costs 100 today will cost a lot more in the future. Inflation eats into the value of your money each year. And hence the monthly budget that you will require when you retire will be significantly higher than you spend today. This makes the planning process complex given that one needs to make reasonable assumptions for future inflation. If one fails to make adequate provisions for inflation in the future, ones faces a serious risk of running out of funds at a late age.

Big ticket expenses: This is a common blind spot. Most retirement planning is focused on our regular living costs. Often the recurring costs such as rent, utilities, groceries are considered while missing out on the one off big ticket costs like major house repair, a serious medical condition, children's education etc. These need to be considered while planning for retirement. These are difficult to predict but you must make certain assumptions for the same.

Changing Lifestyles: This is the biggest blind spot that retirees face. As much as your planning will be based on your desired lifestyle. the lifestyle itself changes. Who would have thought that having air conditioners in the house, previously considered a luxury, is now just a regular requirement? Along with the cost of air conditioners, comes the increase cost of utilities. Add to that the regular cost of servicing and you suddenly start going wrong with the plans. Our lifestyle is changing almost every day.  Eating out at a fancy restaurant was almost an annual event. In the modern times it is a  monthly affair it not even more frequent. All these lifestyle changes have a significant on the retirement planning process.

Is it impossible to plan for retirement? Absolutely not. But it is important to make the right assumptions and consider the above points carefully while building your nest egg. There are many risks along the way. But the most important risk is not planning for the risk.

Watch the video below for some more insights into the subject. 

The magic of compounding

In the world of personal finance, one principle stands above all others: the importance of starting to invest early. The time one allows the investments to grow in the market is way more important that trying to time the market. This seemingly simple concept is often overlooked, yet it holds the key to building substantial wealth over time. Despite its significance, many individuals—particularly in their younger years—fail to prioritize investing, only to regret it later. The magic of compounding, which amplifies wealth exponentially over time, is most effective when given a long runway. In this post I discuss why starting early is critical, dispels common misconceptions that prevent young people from investing, and illustrates the profound impact of early investing with clear examples. By understanding and acting on this principle, you can secure a financially stable future without sacrificing the joys of today.

Compounding is often described as the eighth wonder of the world, and for good reason. It refers to the process where your investment earnings generate additional earnings over time. The earlier you start, the more time your money has to grow, creating a snowball effect that can lead to remarkable outcomes.

Consider two individuals, Smita and Shilpa, who both invest ₹1,00,000 annually at an average annual return of 12% (a reasonable estimate for a diversified stock market portfolio). Smita begins investing at age 25, while Shilpa starts at age 35. By age 65, Smita's investments will have grown to approximately ₹5.42 crores, while Shilpa's will reach only ₹1.68 crores The ten-year head start makes Smita’s portfolio more than double Shilpa’s, despite both contributing the same amount annually. This stark difference arises because Smita’s investments had an additional decade to compound, allowing even small early contributions to grow significantly.

The variable ( t ) (time) has an exponential effect, meaning even a few extra years can dramatically increase the outcome. This is why starting early is not just beneficial—it’s transformative. Without doubt this is the most important factor in the investment process. And yet this is also that one factor where most of us miss out. 

Despite the clear benefits, many young people hesitate to invest early. Common reasons include:

• Living for Today: The desire to “live the life” often overshadows long-term planning. Young adults may prioritize spending on experiences, travel, or luxury items, believing that investing can wait. The mindset of “What if tomorrow never comes?” dismisses the future in favor of immediate gratification.

• Financial Constraints: Early in their careers, many young people face tight budgets due to rent, or entry-level salaries. Investing can feel like a luxury they can’t afford

• Lack of Knowledge: The investment world can seem intimidating, and it was for me personally. The though of investing and having to work with jargon like “dividends,” “portfolios,” and “asset allocation” can be tough.  Without financial education, many avoid investing altogether.

• Overestimating the Sacrifice: Some believe that investing requires giving up all discretionary spending. In reality, even small, consistent investments can yield significant results over time.

These barriers, while understandable, often lead to regret later in life. The truth is that starting small is better than not starting at all, and the earlier you begin, the less you need to invest to achieve the same outcome.

Most of us would be guilty of missing out on the investment process during the early years of our life. In fact I haven't come across any person who can say that he or she feels satisfied about having started the investment process on time. Not a single person. And yet this is probably the simplest rule in the investment process. To start investing as early as possible so as to let the magic of compounding unfold. 

As a young person, we are often swayed by the need to 'live the life'. Often I hear young people say " what's the point of sacrificing the present for a brighter tomorrow? What is tomorrow never comes?" And yet every single one of those person will eventually go on to regret that they didn't invest as much as they could have in those early years.

So how big is this? Is the impact really significant? Do I really need to trade off the good life in my early years? 

I have explained this concept of early investing and the huge impact of a few years on the final outcome in my video below.

Why this blog?

 

Over the last few years I have been hugely intrigued by the process of investing. I may have already achieved financial freedom by the time I had actually started the journey, little knowing that my process may have already given good results. In other words, the process that I had been following over the previous 15 years was pretty much commonplace. 

I found it a bit odd that a simple investing process was hardly understood and not followed by people around me. This prompted me to put down my thoughts and understanding in this blog. Hopefully this helps to shape the thinking and process for others and results in their financial freedom too. 

While I start this blog, I need to mention here that I have already put up a few videos on YouTube which you can watch here   I hope to continue uploading new videos on YouTube and new posts here. 

I am not sure what the path ahead will be. But like other things in my life, we will get to the destination sooner or later.