The shortest and simplest plan to wealth creation - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The shortest and simplest plan to wealth creation 

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In this issue:
» IMF warns of another housing bubble.
» High expectations from Indian realtors?
» Crude oil prices at nine month highs.
» Taking advantage of high prices, promoters release their pledged shares.
» ...and more!

When it boils down to it, we are all participants in the stock market to make money. For most long term investors, the ultimate aim would be to have enough to cover necessary expenses of one's family, and to lead a good, comfortable retired life.

But the fact of the matter is that for creating long term wealth, there are a couple of rules that investors need to follow in order to achieve their life goals comfortably. We came across this plan (summarized by Morningstar in one of its latest articles) that was created by Bill Bernstein, an American financial theorist. As rightly tagged by Forbes, this could very well be 'simplest wealth plan ever'. We believe it is one that is very rational and not difficult to implement.

While it is largely aimed for individuals in their 20's, most of the steps of this plan are ones that need to be implemented by investors of all ages.

So here goes...

Step 1: Saving is essential: Mr. Bernstein recommends saving at least 15% of one's salary - throughout his career - for individuals who start earning at the age of 25 and wish to retire in four decades. Those who cannot save even this much, he believes, tend to be over spenders.

While this may sound easy, it is something to ponder over. We would like to summarise this point by using Warren Buffett's quote - "If you buy things you don't need, you will soon sell things you need."

In short, spend wisely.

Step 2: Knowing what you own: This, we believe, is a trait that investors of all ages must have. For one to make money over the long term we believe understanding of simple theories such as the different dynamics of various asset classes, their risk reward-ratios, basic valuations metrics, would be required to be understood. Not to mention something that we keeping harping about i.e. understanding and knowing the key reason behind getting into a stock. As many legendary investors have stated, if things didn't work out as planned, learn from the mistake and move on.

Educating oneself about the basics of company financials and how they help determine the best stocks to buy, is according to us, a good starting point for novice investors.

Step 3: Increasing knowledge about financial history: An improving economy and consequently earnings levels would make one assume that stocks prices would move in tandem. But as per Mr. Bernstein, real money is made in opposite situations... i.e. future returns tend to be higher when investors buy when market sentiments are not very optimistic.

We had discussed the same matter - the importance of practicing low P/E investing a couple of months ago.

The fact is that it is difficult for investors to identify market bottoms. However, taking cues from broader market valuations - a good substitute for market sentiments - investors can improve their odds and their market returns by investing during times when market valuations are way below the long term averages.

Step 4: Saying 'no' is essential at times: Being overconfident when markets are doing well is a common trait amongst many investors. However, the fact remains that when one has a better understanding of the various aspects of behavioral finance, it would help towards making better investment decisions. We believe that sometimes saying 'no' to certain investment decisions can turn out to be a better call than buy calls.

Warren Buffett's Siamese twin, Charlie Munger has discussed and written great content about the various aspects of behavioural finance. In fact the series, 'Investing Lessons by Charlie Munger' summarizes the key behavioral finance aspects that investors need to keep in mind at all times.

Do you agree with Bill Bernstein's wealth plan? What alterations would you make to it? Let us know in the Equitymaster Club or share your comments below.

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Post election euphoria has certainly given a shot in the arm to stocks across sectors. However, for a few sectors, the prospect of a new government has meant a new lease of life. Take the realty sector for instance. Stocks from the sector were relegated to the 'most hated' category ever since the subprime crisis surfaced in 2008. The fact that several realty companies failed to deliver and many lacked corporate governance also irked investors. With debt heavy balance sheets and wafer thin margins, stocks of real estate companies were at investor mercy over last 4 years. Has the change of government altered their fundamentals overnight? Certainly not! If not earnings growth, will valuation re-rating mean more upside to the stocks? Well, the fact that the BSE Realty Index has nearly doubled on year on year basis speaks a lot about investor confidence in the stocks. But we believe that the price to earnings multiple of most realty stocks are fairly stretched. And without any visibility on earnings growth, investing in these stocks based on sentiments could be a cardinal mistake for investors.

Continuing our discussion on real estate, the memories of subprime mortgage crisis are still fresh in investors' mind. A bubble in housing market subsequently led to such a crash that many institutions/banks had to be wound up. IMF predicts that a similar deja vu like situation is on the cards if governments across the world fail to correct a secular rise in property prices. This warning has come in light of new data which shows that housing prices in many countries are above historical averages. And this could pose a major threat if the price rise is left un-arrested and thereby translating into a bubble.

We cannot agree more with IMF. But in order to curb the price rise lenders have to be more vigilant. And for that matter, the regulatory practices with respect to lending have to be stricter. If somehow the liquidity that flows into the sector can be curtailed prices shall come down. This can be done by making lending norms more stringent so that individuals with below average credit scores do not get access to credit. Thus, regulatory agencies across the world need to pull up their socks. If unprecedented lending continues there are chances that the asset quality of such loans may be poor. This can lead to defaults and thus threaten the banking system leading to another crisis.

For those drunk with the recent stock market frenzy, events in the oil market this past one week could serve as an important wake up call. With tensions in Iraq simmering up, crude oil touched it's highest in almost nine months. And it may not be done as yet. Nearly two-third of analysts and traders surveyed expect crude prices to go up further in the near future. And this straightaway puts pressure on both the Indian currency as well as its balance of payments situation what with crude imports forming a lion's share of its total imports. Thus, this combined with a possibility of a below par rain can seriously hurt country's growth prospects in the near term. Well, we are not saying that these events could pan out for sure but it always helps to keep one's expectations tempered and not invest taking into consideration just the best case scenario.

03:20  Chart of the day
With the rally we have seen in the Indian stock markets of late, everyone is making hay while the sun shines. And one of the beneficiaries of this surge in stock prices is none other than promoters who have pledged their shares in banks. Led by this bull run as well as asset sales, many promoters are getting their pledged shares released from financial institutions. As reported in Business Standard, what typically happens is that when share prices rise, the mark to market value of the loan from banks reduces. So the promoters are then able to release their shares. The issue of promoters pledging their shares rose when the Satyam scandal came to light. If promoters pledge their shares and are unable to honour commitments made to banks, then banks sell these shares. In such cases, the value of the shares drops significantly thereby eroding investor wealth. That is why post the Satyam scandal, SEBI made it mandatory to disclose this data. A large part of the shares pledged in recent times belongs to the construction and real estate sector. This is hardly surprising given that this sector has been grappling with bloated debt and subdued demand. It will be interesting to see whether we see more instances of pledged shares getting released going forward.

Promoters making the most of the market run up

Global markets ended on a mixed note in the week gone by. The markets were weighed down by lowering of global growth forecast for this year to 2.8% vs 3.2% earlier in January by the World Bank. Also increasing concerns over geopolitical tension in Iraq leading to spike in oil prices further weakened sentiments. Barring few Asian indices and Brazil markets, other markets declined. Amongst Asian stock markets Japan and China gained due to the better than expected Chinese economy data and Bank of Japan's encouraging comments on overseas growth and retention of its current monetary policy. China's factory output rose 8.8% YoY in May, in line with market expectations. Indian markets and Singapore markets led the pack of losers this week in Asian. US markets too shed their gains later this week to end in the red. The markets weakened on account of weak retail sales and weekly jobless claims data.

Coming to the domestic markets; the Sensex has declined by 0.7% after touching new life time high earlier this week. The euphoria after stupendous win of BJP seemed to be settling in as profit booking was seen in majority of the sectors. A strong Index of Industrial production (IIP) growth in April (up 3.4%) and lower than expected inflation growth (core inflation up 7.72% in May) was overshadowed by the World Bank's weak forecast for Indian economy and concerns in Iraq.

Performance during the week ended Jun 13th, 2014
Data Source: Yahoo Finance, Kitco

04:55  Weekend investing mantra
"Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error" - Warren Buffett
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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3 Responses to "The shortest and simplest plan to wealth creation"

Prakash Gurba

Jun 15, 2014

Advise for "Saving" is accepted. Other things are difficult for retail invetors to implement.


sateesh kanagotagi

Jun 14, 2014

Generation Y, please note.' if you buy things you don't need, soon you will sell things you need'. Very, very apt.


sateesh kanagotagi

Jun 14, 2014

W.B's quote of business encountering constant change, encounters constant errors . How true is it regarding major business houses constantly merging/ demerging their subsidiary companies at share holders risk
Sateesh K

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