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What can make you wealthier by 2020?

Jun 10, 2010

Gold has truly been the asset of the last decade. While stock markets have been troubled by one crisis after another, gold has kept rising. If we see the metal's 10-year performance against stocks (BSE-Sensex here), it has truly outperformed. Rs 100 invested in gold in January 2000 now stand at Rs 461. Against this, Rs 100 in Sensex is 35% lower at Rs 303. Well, this is not without the fact that at one time (January 2008), stocks were actually outperforming gold. But what happened after that is something you already know!

Data Source: Gold.org, Yahoo Finance

So as we stand here, does investing in gold and not stocks makes for a sound decision? Not really! The fact that gold has outperformed stocks over 10 years makes a case for a higher allocation to the metal. But again, do we need to invest looking at the rearview mirror? Or based on what lies ahead? A peek into the past definitely matters for all kind of investments. After all, we all buy a stock understanding how a company has done in the past. But past is just one barometer to understand what could lie ahead. Understanding a bit about the future also holds some importance.

So, what does the future hold for gold and stocks? Very bright, we must say.

First on gold. Given the way the global crisis is unfolding, investors are starting to lose faith in currencies. Whether it is the US dollar of the Euro, or even the Yen, investors' beliefs have been shaken given the way central bankers are depreciating these currencies by printing more of them. Gold, as such, is being looked upon not as an investment but as a currency whose value can't be depreciated by more currency printing. After all, no government can print more gold in the mint!

Gold is also being seen as an insurance against future crises. This is given that it is the oldest and the only currency that has survived all crises in the past. Even the 'oh so revered' US dollar is just 40 years old in its current avatar. As such, when you buy gold, you do not see it as an investment, but as a store of value against future crises that you might face personally.

In short, gold is money, not a commodity that you buy as an investment. So having a 10% proportion of it in your portfolio makes a lot of sense.

Let's talk about stocks now. We have seen how volatile stocks have been for a large part of this decade (except for the period between 2004 and 2008). As far as the Sensex is concerned, it has gained just around 12% on an average annual basis during this period. But that is the BSE-Sensex, a representative of just 30 large Indian companies, and that too an ever-changing list depending on which stock is performing and which isn't!

Now, as we saw above, the Sensex has returned just around 12% per annum over the past ten years. But one must know that there are multiples of stocks that have never been part of Sensex, but have generated huge returns during these years. And we are not even talking about small shady stocks. We are talking about decent well-managed companies that have grown bigger during these years, and have also shared tremendous wealth with their shareholders. Something like Crompton Greaves, or Asian Paints, or Hero Honda, or HDFC Bank, or even Tata Power.

These stocks were not part of the Sensex all these years, but have outperformed the index (and even gold) by far. And we expect similar kind of companies to continue to outperform in the future as well. So it matters a lot as to what kind of stocks/companies you select for your long term investment. Buying bad stocks and expecting that something will definitely take them higher in the long term is a fallacy. And even buying good stocks at expensive valuations isn't a sensible idea.

So, what kind of stocks outperform in the long run? Simply, stocks backed by good businesses and visionary managements, and available are reasonable valuations. Nothing else will do.

So, as you prepare yourself for the next decade of investing, it makes sense to have 10% of your allocation to gold. This is given that the crisis we are seeing is not going away anytime soon. And even if it goes, the after-effects will remain for long. As for stocks, the allocation needs to be higher, at say around 60-70%, especially if you have a 10-year horizon. While markets will continue to remain volatile in small timeframes, buying good Indian companies (at reasonable valuations) will make you wealthier by 2020.

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2 Responses to "What can make you wealthier by 2020?"

Ravi Karnavat

Jun 19, 2010

I fully endorse the view - both of the author of the article and Mr. Enkayen. Investments in quality companies have given decent returns. Investing in securities is not for a short period of 1-2 years but to fulfill time events like marriage of children or improving life style like purchasing a bigger house. Good businesses have always repaid their owners by making them wealthy.

Ravi Karnavat

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Enkayen

Jun 10, 2010

Very interesting call, but looks like it may happen more in an inflationary scenario fueled by investor excitement from abroad or by institutions who need to put their money to work somewhere. If there is deflation worldwide and here, the Sensex will not necessarily be going up.

If the current average Sensex P/E ratio is around 21-22, and it drops to a more rational 14-16 or so, then today's investors would face a value reduction of their portfolio--and also a buying opportunity.

New money is then more likely to go into specific sectors like infrastructure, energy, fmcg. Real estate giving a return above inflation rates will always remain a good hedge in any condition. Gold always maintains value.

If one is a regular investor on a weekly/monthly basis on a SIP program for stocks, and/or mutual funds, then the cost averaging will also work out in favor of the investor. I agree that at inordinately high Sensex levels one should sell--the difficulty is to know what is too high a level.

In December 2007 and January 2008 when the Sensex was crossing 20,000+ mark and the P/E ratios were around 27, I suggested to a close group of investors that they should bail out and cash in their gains because the returns on the stocks at these levels were not sustainable.

While some followed this, others didn't, waiting for the Sensex to hit 23,000+. I liquidated almost my entire portfolio in favor of cash. Those who did the same 'cried all the way to the bank'-- lamenting the Sensex's rise to near 21,000.

Then came the crash to 14,000 and the tears of the cryers turned to laughter and went on to buy the now heavily discounted stocks to replenish their portfolios.

It is very likely that all the money from FIIs and others will fuel a similar rise to at least 21,000. The current near 17,000 Sensex levels is a good opportunity for selected stocks.

My current strategy is to buy industry dominator stocks, stocks that I see are undervalued currently, stocks that yield a good dividend return (1.5% or more). I have been subscribing to a number of American financial newsletters for some years now and have gathered very useful information relevant to us in India--particular the excellent newsletters from Porter Stansberry and Associates.

I was pleasantly surprised when Equitymaster brought out similar financial newsletters in collaboration with Agora publishing who are also the Stansberry publishers. I subscribe to 3 of the Equitymaster products (Large, Mid and Small cap reports) and find them very useful. By the way--no one at Equitymaster has asked me to write this!

Wishing you success in your wealth building efforts.

Enkayen

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