If you look at the graph of any Index over a long period of time they have created wealth for their holders. Whether it is the S&P500 of the US or the Indian Sensex or Nifty, they all have an upper trajectory. They have created wealth.
This indicates that over long periods of time, the Indices have done a good job of helping investors accumulate wealth in the past. Of course, it’s no guarantee of future results – just a caveat.
Why has the value of these companies gone up over time? There are many reasons.
But mainly, share prices move over the long-term because the company’s earnings were increasing. Over time, if a business earns greater profits, it is worth more because it has the potential to pay out dividends or invest further to earn still greater profits. If profits rise, the business will be worth more and if the business value grows so will its share price. It is as simple as that.
If you were to start a business that was earning you Rs. 500,000 a year would you sell it off for Rs. 5L? Now if the same business earned Rs. 15,00,000 would you sell it off for Rs. 15L? Obviously NO. Similarly when the profits of a company keeps increasing (at an increasing rate!!) it becomes more valuable.
However, this is not so easy as it sounds. People make the following mistakes. These sound simple but can RUIN your retirement plans. It is a place for the serious amateur or for the professional.
- Wrong Time Frame: Salesmen tell you equity investing is for 3-4 years. History says SIP over 10 years makes more sense! If you think that the only way your investments are successful is if you make money each and every month, the only investment alternatives available to you are bank deposits! With interest rates for one-year bank deposits coming in about 6% (before taxes and inflation) it will be difficult to reach your financial goals even though your investments are “successful” (according to YOUR definition). Defining success in investing as ‘never losing’ is a sure failing strategy. Also loss has to be understood well. Losing to taxes and inflation is a loss which many people do not understand. The first and perhaps the most important question you must ask yourself when you define a profitable investment is, over what time frame? And the problem here is that if your time frame is long, you have to make decisions today about a future you are uncertain about – and that is not easy!
- Wrong Benchmark: Your brother’s portfolio return cannot be a benchmark. Nor your friends. Nor Rakesh Jhunjhunwala’s! Your money has to grow at a decent pace and create wealth for you when you retire. That should be the ONLY benchmark that you should worry or bother about. Not the returns that your friends and relatives are getting. Let’s say you invested in a balanced fund. You want to know if your strategy is successful so you compare your performance to that of the sensex. You do a little investigation and learn that your fund earned 10% while the overall market was up 15%. Should you conclude that your mutual fund performance was performing badly? Not really. You invested in a balanced fund which has both equity and fixed income investments in the mix. You invested in that fund because you didn’t want all the risk of having all your money in a growth portfolio of shares. How can you come back now and compare your performance to an all-equity index?
- Uncertain Goals: If you do not know why you are investing, your date of withdrawal should be “indefinite” or “a super bull market”,
Will talk about more mistakes….
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