October 17, 2016

Nice Q&A on power of componding for investors: Madhusudhan Kela

Question: In one of your tweets you said “Compound interest is the eighth wonder of the world. He who understands it, earns it...he who doesn’t..pays it. A powerful force as per Einstein.” What message do you have about people between ages 25 years and 35 years who only want to invest in debt, realty, and the likes?


Answer:

The message is, first, you have to learn from history. First, you see what has happened to various asset classes in a 5-year, 10-year, 15-year, 20-year and 25-year time frame. And 25 years is a very large time frame. A lot of thing which you cannot imagine happen in a 25-year time frame. You’ve had the Iran-Iraq war, you’ve had Hurricane Katrina, you’ve had oil prices moving from $40 to $150, the 2008 crisis of the stock market, the Lehman crisis. So there are many events which happen.

But the reality in spite of that, is equities have compounded at 15 percent plus in the last 25 years. Gold has compounded at less than around 8 percent and fixed income is 8-9 percent. And that’s what I meant, when I said ‘compounding at 15 percent’. Anyone who has a calculator must do this exercise. Just take Rs 100, compound it by 8 percent, compound it by 10 percent, compound it by 15 percent, compound it by 18 percent and then you see that it’s not a difference of 5 percent but a difference of crores of rupees, over a period of 25 years.

I am saying that the case for equities is pretty simple – it is the only real asset which keeps earning. A good company, let’s say HDFC has kept compounding at 15-18 percent yearly. So every five years, my earnings double. If I buy gold, does it yield any return? If I take silver, does it yield any return? No. A lot of these assets are going up because of other reasons. But equities are an inherent earnings story.

If you invest in a good company where earnings are growing 15-18 percent per year, I believe that kind of inherent return is possible to be made. The only catch is that most people end up asking the wrong questions about equities. So the question says “Main kya lelu?” (What stock should I buy?). People want a tip on what to buy and when to buy. That is not the answer.

The answer lies in how much should I buy and for how long. Do I put 5 percent or 10 percent or 20 percent? Eventually people will have to realise that water will only flow where the slope is. So, the money will eventually come. It is a painful point for someone like me who has been preaching it for 25 years. In spite of that, the equity participation by local Indians is very low. It’s time that you do your homework daily.

 If you’re a young person who’s going to be alive for the next 30-40 years then it’s better to invest week by week. It’s not a big technical subject as people make it out to be. It is something which can be easily understood by any one and once you understand that, you have to ensure that you start from somewhere, be it 5 percent or 10 percent of your assets...you start investing. And over a period of time you discover yourself that it is a good investment.

Read more at http://www.bloombergquint.com/markets/2016/10/14/equity-is-the-only-asset-class-which-can-double-your-return-in-5-years-madhu-kela

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