Jehangir’s Jottings – 3: Lessons from the folded paper
In the 3rd of this series of letters to his investors, Jehangir beautifully explains the power of compounding and succinctly tackles several questions that investors ask, including direct equity vs mutual funds, how to select mutual funds, how to allocate across equity fund categories and how to decide when to invest.
Lessons from the folded paper
As a youth, I recall reading something fascinating. It was a question that went something like this; ‘if you fold a very thin (1/1000thof an inch) sheet of paper 50 times, how high would the pile be?’ My brain started mentally doubling the value for each fold, and by about the 10thfold I reached the towering height of one single inch. Unimpressed, I vaguely remember thinking 50 folds would hit the ceiling. Now don’t go reaching for your calculator, just guess. Go on, give it a shot!
I’ll spare you the suspense – the pile would be 1.7 million miles high. That’s 3 trips to the moon and back! You didn’t see that coming, did you? Neither did I, nor will most likely anyone but the most astute mathematician. The human brain is wired to see and understanding ‘today’ – maybe ‘tomorrow’, or even the ‘day after’ - but finds it difficult to look far into the future. This could well be conditioning from our earliest days on the planet, where the only thing that mattered was to locate the next meal and scoot, before the dinosaur located his. So much for evolution.
But seriously, this is the magic of Compounding! Einstein very appropriately termed it ‘the eighth wonder of the world’. In essence, time works in your favour to grow large oaks from little acorns. Warren Buffet talks about it all the time, but the average person dismisses the little acorn all too quickly, not having the patience to watch it blossom and perform its trick. Much like I dismissed my folded sheet of paper that barely made it to the ceiling.
This very neatly folds into the world of investing, the real purpose of this note. While most of us are naturally inclined to spend the bulk of our energy and effort on “which” and “when”, this only serves to divert our attention from the far more important “plant it, nurture it, and watch it grow”.
The obvious questions that beg asking, then, are;
Does this mean that stock picking doesn’t make a difference?
No, it certainly doesn’t if you’re a great stock picker like Warren Buffet. The fact of the matter is that you're not, which is why you’re reading this. Most investors don’t even know how to read a balance sheet, let alone crunch the numbers. Shouldn’t we rather leave it to someone who has access to more information than we do, i.e. a Mutual Fund? Please note my choice of words “access to more information” and not necessarily “knows more than we do”, though the chances of the latter being correct weigh heavily in the Mutual Fund manager’s favour.
Doesn’t this take us full circle back to square one, i.e. which Mutual Fund do we then invest in?
Once again, let me reiterate that nobody really knows which mutual fund will outperform the other in the long run. Your best bet is to spread your investments across a few funds based on stable long-term performance, allocated as under (this ratio is based on what I think will be the best mix for long term growth, and will vary from person to person. Remember that stocks differentiated by market cap categories rise and fall in cycles.
Okay, markets have run up now, so you’ll agree we should wait for a while and see what happens rather than invest it all now?
I do not agree, because very honestly I have no clue as to what the market will do in the short term. And neither does anyone else, for that matter! If they did, they’d be billionaires and too busy looking after their own money to sit and spew their wisdom on the TV. Have you ever heard any market expert say “the market ‘will’ correct over the next 10 days? I bet you haven’t, because they don’t have the conviction to say it, lest they be proven wrong and end up looking sheepish. It’s always “the market ‘can/should/might/may’ correct”. That’s a very forgiving 50-50 chance. If a monkey flipped a coin the odds of being right would be exactly the same, and you 'can/should/might/may' even see him anchoring the new financial markets channel on TV! Instead, what I will tell you is this - invest whenever funds become available, and be clear that you’re investing for the long term. The only thing I do know for certain is that in the long run, equities will handsomely beat inflation and generate additional purchasing power. As an investor, nothing else matters. Everything else is noise, and must be ignored.
What is “plant it, nurture it, and watch it grow?”
Very simply, get your asset class allocation correct (how much in equity, debt, real estate, gold, etc.) based on your financial goals. A good financial advisor - experienced, with impeccable ethics, and not claiming to know the market's next move - will be extremely helpful in this regard. Select a bunch of 6-10 mutual funds based on their long-term track record (remember that the current best won’t necessarily be the best next year, and vice versa), and look at your portfolio no more than once a year. If nothing is drastically wrong (a fund with a solid long term track record, performing poorly for a year or even two years, hasn’t gone “drastically wrong”), the only action that needs to be taken is to keep adding to the portfolio when you have funds available. Our mutual and very dear friend Mr. Compounding will do the rest.
Investing is much like a journey. You know the starting point (investable corpus today) and the destination (your financial goal). There are 2 routes you can choose from;
Route 1, with many short cuts (get rich quick schemes), fly-overs (fancy products, very nicely wrapped), and underpasses (let’s sell now because the market ‘could/should/might/may’ correct and we can get back in again when the market is lower,). You’re weaving your way through the traffic (sell this, buy that). If you know how to successfully manouvre through this maze of excitement, you’re a genius and you’ll reach your destination in super quick time. And that would be wonderful. But getting it wrong could lead to a very serious accident from which you may never recover.
Route 2, a monotonous highway (requiring patience) with pit stops (relaxing over a nice meal and a glass of good wine), gas stations along the way to tank up on fuel (keep investing as funds become available), and the occasional speed bump (market volatility). There isn’t much here by way of action, thrills and excitement, but the countryside is wonderful and you'll reach your destination in comfort. After all, your dear friend Mr. Compounding is in the passenger seat right beside you, gazing into the distance with a cheeky grin on his face. He’s been down this route since the beginning of time, and he knows that there's a big pot of gold waiting at the end.
I know which route I’d take. Call me boring if you will.
A quick bit of trivia to sum up. The Sensex has grown at an average of 15% per annum over the last 40 years. If you invest Rs 1Cr (the proverbial acorn) @ 15% per annum (Mr. Compounding), how high will your oak tree grow in 50 years? A staggering Rs 1,000 Cr. Yes, you read that correct - Rupees One Thousand Crores!
Time is of the essence, dear investor! Please invest some/more money in an equity mutual fund right now. You’ll thank me, and your kids will thank you.
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