Subramoney

This article first appeared on the utvi.com web site - written by the famous anchor, Mr. Vikram Oza. It kind of explains the relationship between risk and return.

The stock markets are risky business. At least that’s the line most people who didn’t park their money in Dalal Street have maintained. But on the flip side, the argument is ‘no pain, no gain’… ‘no risk, no returns’. It’s an age-old dilemma… Damned if you do and damned if you don’t.

Take the case of Nirav Kaku. He’s an IT professional. He, like millions, invested in the stock market consistently during the bull-run. Over the last two years, he parked Rs 24 lacs in it. Today his portfolio has lost half its value. And he’s cursing his luck.

Nirav took higher risks in the hope of higher returns. Was he wrong?

‘Quite’, says Financial Trainer P V Subramanyam. “You may expect higher risks for higher returns, but that’s not always true. To get better returns, sometimes you need to reduce risk – not increase it.”

How do you do that? Here’s an easy approach:

Keep the money you require in the short term (i.e. less than 3 years) in debt instruments.

And invest the money you require in the long term (i.e. like 7 years or more) in equity.

But resisting a ride on the crest of the stock market is tough. Especially when it soars. Blocking out exclamations of joy from those who see the value of their portfolios rise with the Sensex isn’t easy. The trouble only begins when markets do a U-turn and a tailspin all at once. Investors break into a frenzy, and ultimately, despair.

“If you have a long term view, why do you track the markets on an hourly basis?” asks Subramanyam. True. An exercise in futility for all you do is die a million deaths – without hope of nirvana.

Then again, from another perspective, the markets going down are good for young investors. After all you have the opportunity to invest for the long term, getting stocks that you wouldn’t get – at unimaginable prices.

Indeed, with a long term vision, investing in a bearish market isn’t a risk, it’s an opportunity.  Trading is risky, but not investing. As Warren Buffet says, “If you know what you are doing, there is no risk”.

Think about it this way. Not taking a risk is also a risk. For one, the money that you keep under your pillow would erode all its value with rising inflation.

The idea then is to manage risk. Here’s how:

Study your portfolio from time to time, say every six months. And then identify your risks. Your risks will typically change over a period of time with changes in interest rates and inflation. Your default risk also changes when the company you’ve invested money in, goes bankrupt.

Set your goals… the crucial ones like retirement and the not-so-crucial ones like that Tag Heur watch you wanted to indulge in. That way, you’ll see how you can best reduce your risk.

Keep a balanced portfolio. Spread your risks across different asset classes. You should have money in a savings bank account, PPF, Fixed Deposits, Gold, Real Estate and Equity. Ensure you’ve allocated 50-60% in equity with a long term vision and the rest in other asset classes.

Remember! You can’t avoid risk. At best, it can be managed

There are many reasons to buy Gold and hold it. Of course tomorrow I can give you many reasons NOT to own gold also. One reason NOT to own gold is the recent phenomenon in its price. For example if you had invested in gold in 1980 (US $ 590) today it would be worth about US $ 1300! Not much if you consider inflation, is it? As against the sensex which has gone from 100 to about 13,500 (of course after touching 21000!). And the shares would have paid you nice dividends for holding the shares!

However the following are the reasons to own gold:

1. Global currencies are at an imbalance: US $ is not the only currency which is in bad shape. In fact currencies are today at quite an imbalance with each other. So if you do not know whether to hold your money in rupees, lira, yen, dollar, euro or pounds, choose gold. So clearly as much of cash you will keep in your portfolio is the amount of gold you should be having.

2. Investment demand for Gold is accelerating: yes too many people are touting this as a great hedge. And they prove this by doing a 3 year back testing. Fantastic. If you did a 10 year back testing, it will fail and fail badly.

3. Ben Bernanke is converting all the forest in the US into currency! The Gold system having failed, most Central Bank heads are printing too much of currency. Thankfully they cannot create gold.

4. Huge supply and demand gap: India and China will continue to buy gold, as will many other users!

5. Interest rates are more likely to decline, than rise, internationally, adjusted to inflation.

Tomorrow I will give you at least 5 convincing reasons not to buy gold.

Gold as a hedge in your portfolio works, but works over a very long period of time. If you buy gold because it has been going up it would be a wrong reason to buy. However, the fact is, it may still go up - but please stop expecting to get 36% CAGR, that will not happen, for sure.

Hey frankly you do not have too much of a choice, do you?

You would hate to hear this if your financial adviser (financial product salesman) were to tell you, but it is the truth.

You have no choice in seeing where to invest for people looking to hedge against the risk of higher inflation.

Real estate is fine under ordinary circumstances. Internationally real estate is on a death spiral and in India the housing market is in a bad spiral right now. And we may still be away from the bottom.

The old relic - gold - is another good choice, usually. But gold has already appreciated from just over $300 an ounce six years ago to almost $900 today. It could be a little late, or we may at best match inflation.

And RBI Bonds yield much lesser than inflation! Assuming inflation to average 10% p.a. RBI bonds yield you about - 4.6%. That is an awfully steep price to pay!

So, hey Charlie, where can you put money to work today to hedge against the risk of higher inflation?

In shares, as the Englishmen call them or stocks, as the Americans call them. Frankly, do you have a choice? No. Nyet. Nay.

This may seem counterintuitive at first. After all, inflation devalues corporate earnings, the major driver of stock prices. But the mere presence of inflation also indicates that many companies are successfully passing along price increases to customers. This allows stocks to rise even when inflation in climbing.

During inflationary times in India – say during the 1970s and the 1980s stock market indices rose faster, much faster than inflation. And while the average rate of inflation throughout the 1980s was uncomfortably high.

An American analysis found that in inflationary periods - as measured from troughs to peaks some 6 of 10 market sectors in the S&P 500 actually gained ground.

So don’t let anyone persuade you that you should sell all your shares and invest that dough into precious metals, commodities, and real estate. Sure, these asset classes should make up a portion of your portfolio, but certainly not the bulk of it.

Dr. Jeremy Siegel, author of Stocks for the Long Run, has done a study of the returns of different types of assets over the past 200 years.

What he discovered is dramatic. $1 invested in gold in 1802 would have been worth $32.84 at the end of 2006. The same dollar invested in T-Bills, with interest reinvested, would have grown to $5,061. $1 invested in bonds would be worth $18,235. And $1 invested in common stocks with dividends reinvested - drum roll, please - is now worth more than $12.7 million.

The odds are good, of course, that you weren’t around a couple hundred years ago. And, you won’t be around 200 years from now, either.

It’s not necessary to think that long term, however. Start whenever you want and you’ll find that when measured in decades the investment returns for different asset classes are remarkably consistent. Stocks are the big winner.

Since 1926, the stock market has generated a positive return in 59 out of 82 calendar years - or nearly three out of every four years in the US of A.

Since 1980 your investment of Rs. 100 had become 21000 till a few months back and is now at 14,000. And apart from this you got good dividend returns too! This by any stretch of imagination is a great return.

For the past 200 years, nothing has come close to matching the long-term compounded returns of equity shares. However, it is necessary to remember that this has happened only in democracies. So go out and vote and hope that over the next few years of your life we are able to preserve the democracy. If you make sure that the democracy survives, markets will make money, all you need to do is ride it!

We have no clue as to which other asset class can match equity returns! Like always invest systematically in a large index Exchange Traded Fund.

PS: past performance is not an indicator of future performance. The only lesson from history is that you cannot learn from history.

Why should you know Nagnath’s view on the market? When the whole world was pessimistic about India he predicted huge cash inflows. I may not be too wrong if I say that he predicted the bull run in 2002, not in 2008! He always has a balanced view and gives excellent quotes and views to the media.

This is what he had to say at the India equity show - a show organised by www.myirisplus.com at Worli, Mumbai.

When quizzed about the Golden rule of investing, Nagnath quoted somebody (Anon) and said “The man who has the Gold makes the rules”. Apart from sounding good I guess what it means is the importance of cash flows. If the valuations are good, the market is attractive. However for the market to go up, there has to be somebody who puts in the cash. My personal view is that the money can come in from Unit linked Insurance and mutual fund sales - to compensate and more than compensate the FIIs taking money out of the country.

One thing apart from liquidity predictions and analysis is that many people who predict things may get it wrong. When the US $ started getting weak and there was a need for many Americans to go away from the US $, the cash flow caused the Emerging Markets and commodities to boom. Now if there is a reversal, we need to be ready for the same.

When markets go up, we rationalise. When markets go down, we rationalise.

Then he spoke about “regression to the mean” - if you are expecting say 15% p.a return over a 15 year period and you have had a bull run for 4 years where you got say 100% return, maybe you take some profits and keep it away. Similarly if you have got a -13% p.a. for say 4 years maybe you pump more money into the market. My take is “continue your SIPs, stay away from Unit Linked plans” theory will work well.

What causes this tendency of the market to run far ahead of earnings or lag the market for long periods of time? It is cashflow - created by euphoria or by excessive pessimism.

Nagnath also said it is difficult to take a long term view because of the crisis in the US and European markets. He called it an unprecedented short term market crisis - and similar crisis seems to have hit the western world only in the 1930s.

He took a nice dig at Bank balance sheets - and said that after the sub prime crisis, in a bank balance sheet if you saw on the “left side” there was nothing right and therefore quite obviously when you saw on the “right side” there was nothing left. He said that banks have very poor quality of assets funded by high leverage. We saw this in case of Bear Sterns, and now Lehman brothers is raising money for meeting its capital adequacy needs.

About the future Nagnath felt that the markets in the next 12 months are likely to be tough. He had no clue on whether we are finished with the sub prime crisis, are at the half way mark or in which leg of the journey we are. He felt the markets will be worse before it got better. He also predicted a market rally as and when the oil prices hit US $ 100 on the way down.

I attended the India Equity show at Worli Mumbai and heard the following quotes.

S Nagnath said “The Golden Rule of investing is that the man who has the gold makes the rules”

Sundaram E A (ex hdfc mutual fund) said “It is difficult to teach a man something, if his livelihood depends on not understanding that”. He did attribute this statement to somebody else, but I did not get that persons name.

Here is a fine book on personal financial planning! it is called the “Richest Man of Babylon” and was suggested to me by the owner of a cute book shop named twistntales - based in Aundh, Pune.

Here is a book review of the same -hopefully it will inspire you to buy the same, and some of you will be inspired to live it!

Many people think “simple” means easy to do. This is wrong. Completely and totally wrong. Look at an example like getting up in the morning and going for a walk every day.

Though it sounds simple, many of us find the “everyday” really difficult, is it not?

Similarly those who know that “I should save 10% of my salary, but do not” are in that category. If you wish to learn about simple things in personal finance, one book you cannot afford to miss is “The Richest Man in Babylon” by George S Calson.

This book is a guide to financial understanding. It offers insights into how to get money, keep money and make your surpluses work for you. The book takes us to Babylon, the place where the basic principles of finance were established. Babylon became the wealthiest city of the ancient world because its citizens were the richest people of their time. They appreciated the value of money. They practiced sound financial principles in acquiring money, keeping money and making their money work harder.

Historically Babylon is a rich place famous for its treasures of gold and jewels. One naturally pictures such a wealthy city as located in a suitable setting of tropical luxury surrounded by rich natural resources of forests and mines. Such was not the case. It was located beside the Euphrates River, in a flat, arid valley. Babylon is an outstanding example of man’s ability to achieve great objectives, using whatever available means at his disposal. All of the resources supporting this large city were man-developed. All of its riches were man-made.

Seven Cures for a Lean Purse:

The book starts as “Lo, money is plentiful for those who understand the simple rules of its acquisition.

1. Start thy purse to fattening

2. Control thy expenditures

3. Make thy gold multiply

4. Guard thy treasures from loss

5. Make of thy dwelling a profitable investment

6. Insure a future income

7. Increase thy ability to earn

The essence of the book is in the first chapter. Kobbi and Bansir two poor people go to meet Arkad. Arkad is a friend of both Kobbi and Bansir – but very rich. It is nice to see George start the book with both these poor men going to Arkad to learn about finance rather than ask him for a loan or a gift. This is akin to Rich Dad Poor Dad – where Robert Kiyosaki starts by saying that it is not about earning money, but about learning money management. Once you learn money management you know how to earn, spend and invest.

Richest Man In Babylon” is a book that was first published way back in 1926. Since then it has sold more than two million copies and has become a financial cult classic. The brevity and simplicity of the book can be deceiving as it is a powerful little book with a powerful message that can change lives. It is only 144 pages but a dynamite of a book and a very well read book. It is arguably the first book on financial planning – for people who bother to read and implement the book.

Richest Man In Babylon Book Quotes

• “Gold cometh gladly and in increasing quantities to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family.”
• “Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.”
• “Gold clingeth to the protection of the cautious owner who invest it under the advice of men wise in its handling.”

When you read these quotes you realize that what some of the newer money managers are true. It becomes very difficult for a retail investor to know how to invest – it is easier for him to invest through a mutual fund.

• “Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.”

Does not Warren Buffet say “ Risk is when you do not know what you are doing”? Do we not see incompetent “advisors” ruin their client’s portfolios?

• “Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.”

Momentum investing, Investing in fads, day trading, are all ways for a man to lose money. Only the terminology changes but the world is full of tricksters and schemers, so this advise is also timeless.

Countless readers have been helped by this timeless parables of Babylon. The fact that it has sold 2 million copies (and counting) and the fabulous presentation style in a nice manner has ensured its popularity. We in India are of course going the American way in the way we spend. However, reading this greatest of all inspirational works on the subject of thrift, financial planning and personal wealth will surely inspire you to learn about financial planning (chapter 1), budget for your expenses, guard against lending to friends and relatives, own your home, invest in a pension plan, take term life insurance, keep increasing your ability to earn, create a cash flow independent of your job, and using all these techniques become seriously rich and not live from one EMI to the next.

Living in a “socialist” country and having heard slogans like “garibi hatao”, nationalisation, etc. there was some chance that RBI governor does not believe in market economics. But USA? Aw, come on Ben has to believe in free markets, or so we thought. No. He does not.

He comes up with aspirin for patients who need a triple by pass surgery. The Fed is clearly responsible for keeping the interest rates too low for too long and helping the real estate bubble to build. Firms like Bear Sterns should be allowed to die.

Let us take an example. Say there are 5 auto manufacturers - ranked A to E - where A is the best and E the worst. All of them put together make 5Lakh cars. Now if the demand was only for 4 Lakh cars, it is possible that the biggest sufferer is E. So E will bleed and slowly die depending on how well he is capitalised. This will bring the capacity in the industry to 4L cars - and all the other manufacturers will start earning some profits. Sounds simple, but broadly this is how it is supposed to work. Enter BIFR.

BIFR was another stupid socialistic heritage which allowed manufacturer E to be protected against creditors, interest was waived for a certain period, etc. and this allowed E to live a little longer than what the cruel free market would allow. This actually became a hindrance for the freee markets.

Ben by saying Bear Sterns is too big to fail, he has increased the pain in the system. People who speculated wildly have to die - cruelly that is the reward for those who were careful. If excesses are not punished, there is also a moral hazard. Kids will grow up irresponsible and blame Ben!

Imagine your spouse / kid / parent saying “I over spent because credit was available, and the interest rate was only 2% per month”. It becomes your duty to remind them, that it is the prinicipal, stupid, not the interest that is the problem. Only if Ben would wake up.

but surely he has created pain. Those of us who have had a check up KNOW that we need a surgery to remove the 3 blocks. Those who have not gone for  a check up are watching TV and hoping Ben is right. No he is busy creating a gold bubble, an oil bubble, and a real estate bubble - this time he is ensuring that the whole world is in its grip. There could be a crash landing - beware seat belts are of no use once the plane hits the water! 

Why are gold prices going up?

There is actually only one answer - the demand for gold is greater than the supply. In fact this can be the only reason why the share price of any product goes up. Let us look at some reasons why gold prices have been going up - and I can find equally convincing reasons about why gold prices should go down.

So let us look at some reasons why the demand is going up:-

1. the “reserve” currency - US $- is slipping in value. So people who have assets designated in $ would rather designate some of their money in commodities. That means gold. Predominantly gold.

2. Investment demand in Gold is going up - many commodity funds, gold funds, etc. which is ensuring that in countries where there was a big appetite for gold, the demand is increasing.

3. US is surely headed for financial deterioration - with large deficits, inflation and falling interest gold is more secure.

4. Huge supply and demand gap in gold - China and India which is seeing the income of the middle class going up - is seen driving demand

5. Islamic countries are toying with a gold backed currency.

I do not know whether I have made enough case for buying gold. In a few days time, i will have a blog on why you should expect the price to fall. LOL.

It may sound very outlandish and out dated that I do not allow my clients to borrow for investing. In fact I have become very unpopular with some clients for this very reason. However I am against people borrowing against gold, against their properties (top-up loan), personal loans or even a leveraged application in the primary market. I believe you invest what you have. In case you have borrowed and invested - you have been lucky in the past 5 years. Please do not confuse short term tactics with long term investment strategy. This is the tip of the day!