Stock Investment Lesson 1 – Allocate Funds

You have been conditioned to save money in bank fixed deposits and debt instruments like post office deposits, PPF, bonds, chit funds, or in gold.

This was the right way to invest. The right way that our parents chose to meet their financial goals.

I too believed that bank deposits and debt instruments are the best.

I believed that by investing in these fixed income instruments I could create wealth & become rich (as advertised by banks).

But the truth is something else

A fixed deposit (FD) will give you a return of only 6 to 7%. A post office deposit will give a marginally higher.

PPF and bonds give more or less the same returns.

Gold, we Indians have an insatiable attachment for gold that we have created fiscal deficit problems for the government.

As as an investing instrument, gold doesn’t generate any fixed income or dividends.

You only get returns when you sell it.

And depending upon how you are holding it – physical or ornamental, you have to deal with storage costs, making costs, and wastage.

If you invest Rs 10 lakhs in gold jewellery today, you will get Rs 8 lakhs worth metal which will be priced at Rs 6 lakhs in rupee terms 10 years from now.

Investing in Gold is not a guaranteed return over time. You may end up losing money after holding gold for 5 years.

Now what you call safe..

Even 6 to 8% from debt instruments is also a negative return.

Inflation will eat out the returns silently like a termite. 

Let me share a simple example on how inflation works.

Let’s say you have Rs 100 with you.

Today, you can buy 3 good quality apples for Rs 100.

Suppose instead of buying apples, you have invested the same Rs 100 in a fixed deposit for 1 year, it will fetch you 7% return.

You would have Rs 107 at the end of 1 year. Right?

You go to the market to buy apples for Rs 100 and save the remaining Rs 7.

No. Wrong!

Now the same 3 apples are costing you Rs 110. No Surprise the cost of products will also increase in one year.

This is what inflation does to your money.

No growth. No wealth creation.

That’s why you need to invest in an asset class that can beat inflation.

Equity as an investment makes all the difference. No other asset class is more rewarding than equities (the stock markets).

Let me show you how…

I have invested Rs 1 lakh in a recurring fixed deposit for a term of 5 years (2012- 2017) at an interest rate of 9.25% (back then interest rates were high).

During the same time period, I have invested another Rs 1 lakh in some quality stocks (with the help of my expert network and my own knowledge).

At the end of five year period, the fixed deposit value was Rs 1.55 lakhs whereas my stocks were worth Rs 3 lakhs. My investment in equities has compounded at 25% CAGR vis-a-vis 9.25% of FD’s.

The fundamental difference between debt and equity is that

  • debt stands for lending
  • but equity stands for business ownership.

People become rich when they own a business, right?

When you are investing in a debt instrument you are lending money to banks to receive the interest. You can’t receive more than standard rate of interest which is nearly equal to inflation of the country.

Whereas in equities, you are part owner of the business by holding their shares. If the business does well your stock does well too. Because you hold a stake in the company your returns can be multifold.

Your returns will also include stock dividends, stock bonuses and stock splits.

Let’s understand Stock splits. Assume that I hold shares of Amora Solutions at Rs 200 per share. The company has decided to de-merge one of their division (business). That division is being formed into a separate company Bmora Solutions.

As a result, I will soon receive an additional shares of this new company.

Value unlocking leading to wealth creation is only possible in equities.

Show me one person who has become a millionaire from debt instruments alone starting with a modest capital?

Our parents lived by the dreams sold by banks but you know where financial story ends.

Whereas many investors created fortune from stock market (and lost also when they gambled in stocks rather than investing).

Let me share a story that I learned from one of my investing mentor.

Long before Wipro became the IT giant it is now, it was a producer of vanaspati, a type of vegetable cooking oil. It was then known by the name Western India Vegetables Products Ltd. established by Azim Premji’s Father.

The company’s plant was setup in a small town called Amalner in Maharashtra. Many of the plant workers from Amalner were shareholders of the company. In 1966, Azim Premji became the Chairman of the company after the demise of his father.

Premji renamed the company to Wipro in 1977 and in 1979 when the Indian government asked IBM to leave the country. He began to steer the company towards the computer hardware and software business.

Wipro’s value skyrocketed in the late 1990’s and Premji became one of the richest persons in the world, a position that he still retains.

While the Wipro’s story unfolded in a spectacular fashion, many of the plant workers became Crorepati who were shareholders of the company.

Suppose, you held or bought 10 shares of the stock at a face value of Rs 100 per share in the year 1980 (when Wipro started moving towards computer business) the value of that initial investment of Rs 1000 would have grown in this fashion:

In 1980, initial investment of Rs 1000 with 10 shares being held

In 1981, the company declared 1:1 bonus, making the total number of shares 20

In 1985, the company declared 1:1 bonus, making the total number of shares 40

In 1986, the company stock split the share to Rs 10, making the total number of shares 400

The company did numerous such bonuses and stock splits since 1980.

The latest ones being a 2:3 bonus in year 2010 and 1:1 bonus in year 2017.

Making the total number of shares held from 1980 to 2018 to be 19,20,000

The current stock price of Wipro is Rs 290, making the value of initial investment to be Rs 290*19,20,000 = Rs 56 crores approximately.

So, Rs 1000 became Rs 56 crores.

Yes, I understand that the time frame is 38 years. But no other investment would make you rich with investment of Rs. 1000.

I was born in 1984, what if someone would have gifted me shared of Wipro as my birthday present with a condition to sell only after my marriage?

Do you know that Wipro has paid multi crore rupees as dividends to its shareholders over those years?

There are still many people in Amalner who hold Wipro’s shares whose collecting holding amounts to thousands of crores at current stock price.

This is just one true story.

I can give you tons of examples of how good companies led by honest and able management have delivered 2X, 3X, 5X, and even 10X returns in a span of 2 to 5 years.

Britannia whose biscuits you regularly buy in the supermarket has delivered 10X returns in the last 5 years.

This is the power of equities which no other asset class can match including real estate which has its own share of problems in terms of returns (10% CAGR), ease of handling, liquidity, huge initial capital etc.

I agree, equities are risky compared to other asset classes.

And not every company listed on the stock exchange is a Wipro.

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