Frequent changes to your investment portfolio can be detrimental

The list of top performing stocks or mutual funds keeps changing frequently. This is of course obvious as the performance depends on various factors and some of these factors are not completely in control of the company’s management. Even good companies with sound management will face ups and downs. There is one obvious question that comes to every investor’s mind – Do we keep churning our portfolio frequently to exit the underperformer and buy the outperformer? My answer to this is overwhelming ‘No’. I believe churning of your portfolio too frequently will do more harm than good.

Let me try to explain further. During the last 15 years, Nifty (including dividend) has grown at an annual rate of 16.7%, to put it in simple terms, Rs. 100 invested 15 years back has now grown to more than 10 times. But, having said that, equity as an asset class is known to be volatile in short periods (see chart below). So, while investing in equity for short term may be tricky, the odds of making money in the long term are quite high.

Now, let us come back to ‘Power of Compounding’, which we had touched briefly in my last article (Read here). This has to be one of the most important financial lessons of all time. As the great Albert Einstein said “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it”.

Here, we will see how holding your portfolio for the long term helps power of compounding play its magic in the most unusual way. If you hold your portfolio for long term, the winners in your portfolio will tend to become dominant, and the losers will become insignificant. The positive impact of the winners will significantly outweigh the negative contribution and your portfolio will compound significantly. Not sure, right? I can understand your circumspection.

Let me explain this by taking a simple two stock portfolio. Stock ‘A’ is a winner, gives 25% annual return over a period of 15 years, while Stock ‘B’ is declining by 25% annually. How has your portfolio performed? I would say good, rather great. Your portfolio has given an annual return of 19.4%. This example demonstrates the power of compounding.

This magic can also work for you. You just have to be patient and give your money long enough time to grow.

Planning to fail in your golden years?

Yet again, a discussion with few friends on a Sunday afternoon has brought me here today. We were discussing about our future plans and each one of us wanted to retire early and retire rich. No surprises there. What surprised me is that my friends only have a vague idea, no concrete plans about how they are going to achieve this goal. This is true for most of us. With rising cost of living and increasing life expectancy, the need to plan for one’s golden years is absolutely necessary.

Lack of a concrete plan for retirement may lead to problems just when you are least prepared for it. As one of the founding father of the United States, Benjamin Franklin, so succinctly put “If you fail to plan, you are planning to fail”.

Most of us tend to underestimate the retirement corpus. If you need Rs. 50,000 for monthly expenses today, will you need the same after 30 years, when you retire? The answer is no. You will need Rs. 2.2 lakhs every month, assuming just 5% inflation. There it is, now I have your attention. Inflation leads to reduction in purchasing power, by slowly but steadily eating up your money. Learn more about it here.

Let me tell you one more thing. With increasing life expectancy, the non-earning period in an individual’s life is expanding. Someone retiring at age 60 after working for 30 years could live on for another 25 years or more. Assuming your current age of 30 years, current monthly expense of Rs. 50,000, inflation of 5% and retirement age of 60 years, the amount of retirement corpus one needs for 25 years after retirement is Rs 5.3 cr and for 30 years after retirement is Rs. 6.1 crore. These are not small sums by any measure. If you do not start to plan now, there is a high probability to fall short.

Are you now thinking when to start investing for retirement? The answer is as EARLY as possible. If you do that, your money gets more time to grow. Each rupee gained generates further returns. This is called “power of compounding”, and this helps you get rich… and richer over time.

Let us take the above example, say you start investing at age of 30 years and continue to do so for next 30 years. To achieve a corpus of Rs. 5.3 cr at retirement, assuming 12% return on your investment, you will have to invest Rs. 15,391 per month. If you delay the investment by even 5 years, the same monthly installment doubles itself to Rs. 28,630.

Don’t feel overwhelmed by all the numbers shown above, you can take help from your financial advisor for this. The key is to start early, invest regularly and choose the right products for your investments.

Start small but start early

The other day, my mother asked me to teach her cycling. I went speechless for a few minutes, until she spoke up – “I taught you cycling when you were three. Why can you not spend time teaching me now?” I wish I could tell her, “Mom, I was three and you are Sixty – Two!!” But nonetheless, we took an attempt. And what happened next – Umm, another story, another day!

But thank to almighty, she did not come up with a similar argument for money. Imagine my situation had she said “I started building your college fund even before you were born. Why can you not give me an equally hefty amount to retire peacefully?” Phew!

Not sure if I can give her a large enough fund for her retirement, but I surely don’t want to be saying that to my kids. Certainly, there are some things which are better started early in life!

I could not be more convinced when I did some math to understand the benefits of starting to invest early. Assume that today is your 25th birthday and you start investing Rs. 5,000 every month. I get inspired by your decision and start investing the same amount every month. And hey, Happy Birthday to us! I turn 35 today!

Years continue to pass and we continue to invest Rs. 5,000 every month. At the age of 60 I decide to retire and that is when I feel that it is time I make use of the wealth I have created for so long. So I login to my investment account and whoa… what do I see? At an average annual return of 14%, I created wealth amounting to Rs. 1.3 Cr. Satisfaction redefined.

But 10 years later, when you turned 60, that is when I realized what regret truly feels like. At the same average annual return of 14%, you had created a wealth pool of Rs. 5.6 Cr.!!

Perplexing! How was that even possible? 4 times the amount of wealth I created?

Yes my friend, that is the impact a difference of 10 years can make. While a simple mathematic calculation will present to you this fact, the logic behind this is in the “Power of Compounding”.

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it” – Albert Einstein

Wondering how it works? Assume that my investment of Rs. 5000 in the first month grows to Rs. 5,050 by the second month. So, in the second month, I am actually investing Rs. 10,050 (5,050 from previous month and a fresh 5,000 for the current month).

The above example presents some very critical learnings.

In the prime of our youth, we have a tendency to be a little generous as far as our spending habits are concerned. If we avoid reckless expenses and shift a defined amount towards monthly investments, the benefits will be visible once the invested amount matures.

Secondly, early on in life, it is relatively easy to park a part of our salary in good investment instruments every month. Such small investments, when accumulated over time, will give us the financial security we have always needed in our lives.

How do we help?

At CAGRfunds, we help you start investing through SIPs. No matter how small you want to start, we help you create wealth in the long run.

To know more whatsapp us on +91 97693 56440