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This can greatly impact your returns! - Views on News from Equitymaster
 
 
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  • Jul 20, 2010

    This can greatly impact your returns!

    Chirag and Hitendra, both of whom recently retired decided to meet up. While both friends had studied together and started their careers together, Chirag had worked in the finance sector and Hitendra had joined the marketing department in a small firm. Today, after a number of years they decided to meet up at their favorite hangout from their college days.

    Chirag drove up a few minutes early and parked his car in front of the cafe. The cafe brought back old memories and he started thinking of Hitendra in his clean but worn out clothes and the number of times he lent him money as Hitendra was unable to pay his various bills. So Chirag was more than a little surprised when Hitendra finally arrived and looked financially quite well off.

    In the cafe after the pleasantries, Chirag could not hide his surprise and blurted out what was on his mind.

    Hitendra laughed and told him his story. "See", he said, "when I was 20, I inherited Rs 100 thousand from a relative. This money I decided to invest for long term. Everyone, whom I asked for advice, guided me to put this money in a mutual fund. Being only 20 years old, they said, I could take the risk of investing all this money in the equity markets. The benefit of mutual funds, they said, is that they are run by professional managers who will manage my money and keep it safe. However, they will charge me 2.5% of the total amount invested with the fund for their services. Being young, I decided that this money I would invest myself in the stock market as I thought that it would be a learning experience.

    When I started off I lost a lot of money listening to other people's tips on stocks. At times, I thought that I had been foolish not to invest in mutual funds. Then however, a neighbor guided to read about finance myself. I started reading financial newspapers and devoting a few hours every week to reading financial books and annual reports of companies. It was then that I started investing cautiously and in only those company's whose long term potential I believed in. Gradually I recovered my lost money and when I retired last month my corpus from my initial investment was Rs 26 m. This was at a compounded return of 15% for 40 years which incidentally is also the long term return of the Indian stock market.

    However, you will be interested to know that my younger brother had also received a same amount from this relative. He had then invested it in mutual funds. Last month his corpus from this 100 thousand stood at Rs 9.7 m. Why do you suppose this happened? You see his total management fee over the last 40 years was Rs 1.9 m. This is 20% of his end corpus. But you are familiar with the power of compounding. Had that 1.9 m not been deducted, he also would have got a 15% annual return like mine and ended up with a corpus similar to mine. Instead he got a 12% compounded annual growth rate and this ended up with him losing Rs. 17 m at the end. In other words, his total corpus at the end of the period would have been more than 2.5 times than the amount he ended up with had he achieved the same result without paying the 2.5% management fee."

    With this Hitendra smiled at his friend and said, "today's lunch is on me".

     

     

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