Image credit: Vishal Khandelwal
Author: Arpan Khanal
Since it is graduation season globally, I thought of sharing a few things I wish I knew about Investment when I was graduating. If you are younger than graduating age (<22 years old), this article could be even more useful for you and if you are older, there is no better time to start than today!
Despite evolution, certain aspects about humans do not change. That is because these behaviors are necessary for our survival, as individuals and human race, and they are biologically coded into our DNA. Such behavior includes our need to eat, our desire to find a suitable mate, and flight instinct when we sense danger. You could be living during the stone-age or in today’s hi-tech world in California: it simply doesn’t change.
One of such fundamental non-changing behavior is our desire to accumulate wealth. In prehistoric times where there was no other possession, the hunted food that lasted for a few days was accumulated by the physically strong. During the prevalence of agrarian societies, wealthy hoarded agricultural land and during the industrial revolution, it was industrial machines that were hoarded by the wealthy.
The mediums which represent wealth, change over time – from agricultural land to gold, to currency, but what does not change is our desire to get wealthier. But despite this desire to accumulate wealth, many end up not wealthy. Why is that so?
Knowledge and habit. So through this blog, I seek to transfer some of whatever little knowledge I know about getting rich and also the habit-pitfalls that prevent 90% of you from getting rich. Let’s get started and help you get richer!
Size doesn’t matter
“If you think you are too small, try sleeping with mosquito in a room.” – Dalai Lama
Often, I meet young people who want to start investing. But when I ask them what stops them from starting, they tell me – ‘It’s a small amount. When I have a significant amount, then I will start to invest.’ This thought process needs to change in order to get wealthy.
Warren Buffet started investing at the age of the age of 11 and he invested all of the $114.75 he had started to save since he was 6. Today, his net worth is ~$84 billion. He did not wait to earn his first million dollars to start investing to get wealthy. Instead, he realized that even a small amount, if invested over a long period of time, can make you incredibly wealthy.
Start early
“Life is like a snowball. The important thing is finding wet snow and a really long hill.” – Warren Buffet
Miss Smart Compounder starts to invest at the age of 30 and with a sum of $100,000 she will have amassed a sum of ~24 million by the age of 60, if her investment manager generates an annual return of 20% per year. Not bad, huh?
Now let’s change the scenario a little bit. Imagine if Miss Smart Compounder inherits $90,000 from her grandmother on her 20th birthday and along with her personal saving of $10,000, she starts investing in the stock market. Allowing this money to compound at the rate of 20% per year, this sum of $100,000 would accumulate to ~147 million by the time she is 60. Wow!
In both the cases the initial amount is $100,000 and the rate of return is 20%. However since Miss Smart Compounder accumulated extra ~123 million by her 60th birthday just because she started 10 years earlier at 20!
But what if Miss Compounder started at 30 with $100,000 and she wanted to accumulate ~146 million (as was the amount accumulated in the second case)? Her money manager would have to compound $100,000 for the next 30 years at a compounded rate of 28% per annum. Now, I am not saying that’s impossible, but in case her investment manager does that, he belongs to a league higher than the greatest investor of all time – Warren Buffet. For the last 50 years, Warren has compounded his wealth at the rate of 20% per annum. Good Luck Mr. Money Manager!
The best time to start investing is yesterday. The next best time is today. Start early; allow compounding to work its magic and you will get wealthy!
Compounding
“Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein
Let me combine the two points mentioned above and explain the most important yet the least taught and talked about concept in investing – Compounding.
Compounding is not very complicated. In fact, in this part of the world, most of you, like me, must have studied about Compound Interest when you were 12 years old. So you understand that if you invest $100 at 20% you will get $120 at the end of Year 1. However, in the second year the amount you start investment with is ~120 ($100+$20 interest), so 20% on $120 is $24. This makes your investment sum at the end of Year 2, $144. Unfortunately that’s where teachers stop. Here’s what they don’t teach you:
If you continue to invest that same $100 at 20% compounded for 50 years, you would end up with ~$1 million. You do that for 100 years, you would end up with a WHOPPING $8.28 billion in your account. Isn’t that magical? No wonder Albert Einstein, who studied the mysteries of the universe, chose to label Compound Interest as the 8th Wonder of the World.
Compounding works like magic in the long term. While a lot of investors focus on “Return” component in the Compound Interest Equation, the real component that they could focus more on is “Time”. I told you about the track record of Warren Buffet, the greatest investor of all time, who generated 20% compounded for 50 years. So if you really want to get wealthy, I think you would be wiser if you lowered your return expectation and rather focused on time, which you can directly control.
I advise younger people to apply Compounding to all aspect of life – career, education, relationship, learning, sports. Play the long-term game and you will experience the magic of compounding, first hand.
The above mentioned three points were about Knowledge. Now let me tell you why despite having knowledge, statistically, 90% of you will falter on the path to wealth creation – Habit.
First save and then spend
“Do not save what is left after spending; instead, spend what is left after saving; because if you buy things you do not need, soon you will have to sell things you need.” – Warren Buffet
Investment in simple language is when you forgo consumption today ($100), deploy that money somewhere else so that you generate more money sometime in the future ($120). Morgan Housel has a slightly differing view where he defines investing as – how people behave with money. I think getting wealthy is a combination of the two. However, this part focuses more on Morgan’s point of view.
Your ability to say NO to almost everything will determine how much wealth you will accumulate.
In order to successfully create wealth, you must differentiate between what you want versus what you need. Everyone around you is selling you something or the other. Cristiano Ronaldo is selling you Nike shoes, Kylie Jenner is selling face creams, and Elon Musk is selling you some expensive car. A lot of those products could be items you WANT but you DON’T NEED.
Imagine you are fresh out of college and at 22 you make $5000 per month. You like the new Tesla Model 3 worth $35,000 and you decide to take a credit where you pay $1,000 per month to the Bank. In one year you would have paid the Bank $12,000 and by third year you would have spent $36,000 (apart from interest cost). Instead of owning a Model 3, if you had bought another less fancy car for just half the price ($17,500), by third year you would have saved $17,500. If you invested that saved amount at 20% compounded for another 25 years, you would have $1.7 million in your account by the time you are 60. Even if your money manager generated 15% return during this period, you would have ~$600,000 by 60.
There was a famous experiment done at Stanford University called the “Marshmallow Experiment”. (I recommend everyone to watch the video here.)
Its takeaway is that – Your ability to control your emotions will determine how successful in investing and in life general.
Invest in Equity
“You only need a few good stocks in your lifetime. I mean how many times do you need a stock to go up ten-fold to make a lot of money? Not a lot. “ – Peter Lynch
It is not adequate that you save money. You must invest what you have saved. But where? There are several asset classes and each of them have their own investment characteristics. I recommend Equity as an investment option.
Firstly, historically over the long run, returns generated by equity investment have been unmatched by any other asset class. Secondly, when you invest in equity your upside potential is unlimited. Thirdly, when you invest in equity, you are partnering with the smartest entrepreneurs & managers in the country and owning a piece of a wonderful business with them. As their company’s earnings increases, their fortunes rise and so do yours. So you can own wonderful pieces of business by partnering with Bill Gates, Warren Buffet, Jeff Bezos, Jack Welch, Dhirubhai Ambani, Kichiro Toyoda or Binod Choudhary. How wonderful is that?
But there are thousands of listed companies globally. Majority of them are worthless and bad investments that can lead to loss of money. When we invest in equity, we should search for attractive companies that have strong competitive moats run by competent managers. Is it easy to find such companies? No. Is it simple to find such companies? No.
But over a period of time, through knowledge and experience, you can teach yourself to identify such businesses. Or you could simply hire us. We, at KPIS, would be glad to help you find them. Through our in-depth research, we seek to identify attractive, growth-oriented companies which can create wealth for investors. All we charge in exchange is a small performance-based fee.
Those are the basic rules to getting wealthy. It’s simple, right? Let’s see how many of you can do it. Let me summarize them for you.
- Size doesn’t matter
- Start early
- Compounding
- First Save and then Spend
- Invest in Equity
Nothing fancy. No rocket-science. No magic formula. Just simple and basic rules.
WILL YOU BE ABLE TO RETIRE EARLY?