Basics of investing

2020-2023 • Kannan
Story of a father and his 2 sons

First son is married; has a child. Before getting the second son married, he dies in an
accident. Father gives the money to the older son and asks him to keep the money for
his own child’s wedding expenses. If he keeps the money as a bank deposit for the
next 25 to 30 years, will that money be enough to get his child married?

The answer is No because inflation.

Most safe investments are ‘leaky buckets’

Safe investments such as bank deposits grow slower than inflation, especially after
taking taxes into account. More on this on the next slide.
Inflation – decrease in purchasing power
● We spent around ₹2,15,000 in 2002-05 for my post graduation.
● The same degree would cost a lot more today.
● When my son goes to college, it would cost several times more than what it
costs today.
● This is known as inflation: ‘purchasing power’ of each rupee goes down over
time.
● All future financial plans must take inflation into account.
● Different products/services have different rate of inflation. Inflation rate of
foods are usually less than education and healthcare, for example.
What’s the harm of inflation?
● Let’s say if my son can graduate with ₹10,00,000 if he were to go to college
today.
● Let’s say I do have ₹10,00,000 with me today.
● If my money doesn’t grow in sync with inflation, I’ll have to keep earning more
and more for college expenses until my son graduates.
○ because the price keeps going up but my corpus is lagging behind
● If we need to keep on earning continuously for the same (future) expense, how
will we ever have enough money?
Some risks, such as share market risks, are common knowledge. But there is a risk in
pretty much every single investment.
Risks in different investment assets
Share/equity market ● Volatility and unpredictability
● Very difficult to choose companies to invest in

Lending for interest ● We may not get the interest and/or the principal back

Bank (savings account, ● Interest rate much lower than inflation rate
fixed deposits) ● Investments above ₹5,00,000 are at the risk of the bank collapsing

PPF, SSY, etc ● Long lock-in period

Gold ● Volatility and unpredictability

● Emotional stress when families have to sell gold

Real estate ● Hard to buy and sell (illiquidity)

● Some amount of work is required
● May not find tenants; tenants may fail to pay rent
Strengths of different investment assets
Share/equity market ● Only asset class known to beat inflation (over long durations)
● Very low income tax when held for more than a year

Lending for interest ● Higher interest rate than bank deposits

Bank (savings account, ● Very liquid; equal to cash in your pocket

fixed deposits) ● Insured up to ₹5,00,000 (caveat)

PPF, SSY, etc ● Higher interest rate than bank deposits

● Income tax benefits

Gold ● Not affected too much by inflation

● Most people think gold is a safe investment

Real estate ● Can act like pension income

● Most people think real estate is a safe investment
I stole this slide from Quantum Mutual Fund’s talk on Asset Allocation.
What’s your ‘risk appetite’?
● Many answer this question without fully understanding the implications
● Anyone investing in shares (including equity mutual funds) must understand the
risk behind volatility.
● Someone shared this on a Facebook forum, and I think this is brilliant.
○ Low risk appetite means “I am fine with 5 to 6% return”
○ Medium risk appetite means “I am fine with anywhere between -1 to 9% return”
○ High risk appetite means “I am fine with anywhere between -8 to 13% return”
○ (Don’t focus too much on the numbers (6% vs 9%) but rather on how wide the window is.)
● Equity is very volatile in the short term, and stabilises slowly as the tenure
increases.
Volatility makes investing difficult
● Let’s say I have saved ₹5,00,000 for a wedding that’s expected to happen in 6
months.
○ How much of this money can I keep in the form of equity?
○ Likely answer is ₹0 or very close to ₹0
● Let’s say I am saving for retiring in 20 years.
○ How much of this money can I keep in the form of equity?
○ Likely answer is 70% or more
Goal based investing
Why are goals necessary?
● Multiplying money, having a big bank balance, etc are meaningless by
themselves
● Money is needed for basic needs, improving quality of life, and celebrations
○ Kids’ education and wedding
○ Life after retirement
○ Travel and vacations, purchase of car or house, etc
● Planning how much money is needed for what goals and when will give purpose
and structure to investing
● Goals also give us a framework for how much risk we can afford to take (see my
blog post on this)
Dealing with market volatility
● Market investments can have unpredictable ups and downs.
● Entering the market is easy; exiting without a loss is not.
● We need a strategy for entering and exiting markets if we want to avoid losses
due to market volatility.
○ Buying shares, gold, etc for a specific amount at a fixed date every month, over several months
continuously, will let us buy assets at an average price.
○ Similarly, we should also gradually withdraw from the market over several months.
● If we know in advance when we need the money, and how how much we need,
we can gradually exit the market.
What can I do next?
● It’s much better to list your goals and then start investing, but if you must invest
today…
● Start by building an emergency fund
○ 3 or 6 or 12 months expenses (plus loan EMIs) in bank deposit or liquid fund
○ If your long-term investment is a garden, your emergency fund is the protective fence around it
● Get life and health insurance
● Invest in equity in bonds
○ Maybe 50 or 60% into a Nifty index fund (can be Nifty 50, Nifty 100, Nifty 250, or Nifty 500)
○ Remaining in a liquid or money market fund
○ Remember to count your EPF contribution as debt: EPF+liquid should be 40 or 50%
○ Invest ₹500 or ₹1,000 per month until emergency fund and insurance are in place
Avenues for investment planning
● If you want to do it yourself (DIY)
○ [FREE] My own investment planner & tracker.
○ [FREE] Kuvera provides goal planning features, but they don’t seem to work that well these days.
○ [PAID] ETMoney Genius looks interesting, but I don’t have enough information to make a
recommendation for/against it.
○ Many other ‘robo advisory’ spreadsheets are available online, both free and paid.
● If you’d rather leave this to a professional
○ Interview a few advisor and choose the one you like.
○ See my document on choosing a financial advisor for some advice.
Some fundamental ideas

Understanding how each investment works will enable you to appreciate the risks and
opportunities. Understanding these are important because taking risks without
understanding is an easy way to lose money. You should only take risks that you are
comfortable with.
2 ways to make money
1. Lending money for interest
2. Doing a business (that makes something or provides a service)
Lending money
Lending money for interest
● Not just lending to individuals we know
● The money we deposit in a bank is our ‘loan’ to the bank
● Banks ‘borrow’ from depositors and lend to ‘lenders’ at a higher interest rate
● EPF, PPF, SSY, soverign bonds, etc are individuals lending to the government
Investing in loan/debt means…
● Also known as ‘fixed income’ investment
● Rate of return is predetermined at the time of investing
● No matter the circumstances, the borrower must repay principal with interest
○ Borrower might go bankrupt, but that doesn’t remove the loan liability
● On the flipside, interest won’t increase even when the borrower makes
over-the-roof profits
○ ICICI Home Finance pays over 7% interest for fixed deposits
○ Doesn’t matter if they lend that money for 10% or 12% interest: depositor gets not a paisa more
than 7%
Doing a business
Doing a business
● Do something that customers will be willing to pay for
● Business might earn a profit, or suffer a loss; there’s no guarantee
● A business that have been profitable for 4 decades might suddenly start losing
money
● Profit or loss on the business is mostly determined by the knowledge and skills
of the people who run the business
Investing in a business means…
● Right opposite of ‘fixed income’
● No one can tell how much profit will be there
● One could make more profit than expected, or end up losing money
● A business that’s losing money can be turned around to make profit (and the
other way around too)
An ‘ordinary’ person
I am just an ordinary person. I have a job and a family. They keep me busy all day. I
don’t have time to run a second business. I don’t want to lend money and chase
borrowers to get it back.
Investing in share market
● Capital needed for a business may not come from one individual or a family
● One company is split into lakhs or crores of equal shares and each share is sold
individually
● Each shareholder gets equal share in the profits and losses of the business
● Share market investor can earn money through business without having to
directly run the business
‘Diversification’ in share market
● Invest your money in a diverse set of companies
○ diverse comapnies, diverse industries, diverse countries, …
● When one company makes losses, other companies will make profits
● Overall, you won’t have incredible profits; neither would you end up losing all
your money
Mutual funds
● Each fund is a diversified portfolio
● Different funds diversify in different ways
● Equity mutual funds buy shares of 20, 30, 50, or more companies
● Mutual fund investors can enjoy profits of those companies or suffer losses
from those companies
An oversimplified example
● Net Asset Value (NAV) of a hypothetical fund in 2020 is ₹51.
● This fund holds shares of 5 companies at ₹10 per company.
○ ABC Bank: ₹10
○ Ujala Cements: ₹10
○ OurHome Builders: ₹10
○ Heartrite Pharma: ₹10
○ FutureSoft Software Company: ₹10
○ Fees for running the fund (aka expense ratio): ₹1 (expense ratio of ~2%)
Oversimplified example continued…
● In 2021, value of these holdings change
○ ABC Bank: ₹8
○ Ujala Cements: ₹9
○ OurHome Builders: ₹6
○ Heartrite Pharma: ₹12
○ FutureSoft Software Company: ₹11
○ Fees for running the fund (aka expense ratio): ₹1 (expense ratio of >2%)
● By the end of 2021, our investment is worth ₹45
● Anyone selling their MF units now is turning their ‘unrealised’/‘paper’ loss into a
real loss.
Oversimplified example continued…
● By 2024, the holdings change value like this
○ ABC Bank: ₹15
○ Ujala Cements: ₹13
○ OurHome Builders: ₹14
○ Heartrite Pharma: ₹13
○ FutureSoft Software Company: ₹9
○ Fees for running the fund (aka expense ratio): ₹1 (expense ratio of <2%)
● By the end of 2024, the investment is worth ₹63
● Those who sold in 2021 suffered a loss of ₹6; anyone selling in 2024 would have
earned a profit of ₹12.
● There is no real loss or profit until you sell. This is very different from a bank
deposit.
What can you invest in?
● There is no universal rule; invest according to personal needs and preferences
● What’s right for someone at 30 years age won’t be right when they are 60
● General advice is to invest in shares (equity), debt (lending), gold, and real estate
○ When one asset class is not making money, others would
● How much to invest in what asset is also very personal based on personal needs
and preferences
○ This is called ‘asset allocation’ and changes over time according to changing circumstances and
needs
Investing early can make a huge difference
● Mr A starts investing at age 25; Mr B
starts investing at age 30.
● Mr A invests ₹50,000 per year. Mr B
invests ₹62,500 per year.
● At age 50, they have both invested
exactly ₹12,50,000 each.
● But Mr A has a corpus of ₹54,00,000
while Mr B has ₹39,00,000.
● The only difference: 5 years head start.

Caution: This example is too simplistic in that compounding is not applicable to mutual
fund investments. But the main takeaway here is not compounding, but the advice to
start investing early.
Advice on mutual funds investment
● ‘Regular’ mutual funds have a higher expense ratio because they pay yearly
commissions to your broker
● ‘Direct’ mutual funds don’t pay such a commission. You could be saving a huge
sum.
○ The commission is pretty much invisible. Don’t get fooled by banks/brokers.
○ If the fund name doesn’t explicitly say ‘direct’, it’s a regular fund. Do not invest in that.
● I highly recommend goal based investing. My own spreadsheet is fairly
simplistic, but there are other tools online.
● Use my Kuvera referral code if you’d like: both of us will get 100 Kuvera Coins
as a reward (worth ₹100).
○ Referral code: JK1P3
○ Direct sign-up link: kuvera.in/s/twt?referral=JK1P3
Important topics not discussed here
Start your goal-based investing as early as possible. Delaying leads to losing out on
potential earnings. Also make sure to learn about the following.

● Asset allocation
○ Don’t just consider your mutual funds investments; track your entire wealth
● How to mitigate risks in each asset class
● Goal planning and glide path for asset allocation
● How are earnings from each investment taxed; how/when to pay them
● Active investing vs passive investing
Some sources for learning more
● Books
○ I Will Teach You To Be Rich (US centric)
○ Rich Dad Poor Dad
● FreeFinCal provides a lot of valuable advice to ‘DIY’ investors
○ Web site
○ Free eBooks
○ YouTube channel
● Kuvera
○ Blog
○ YouTube channel
● Shameless plug – my own blog
Some tips for individual investors
● Always track your entire portfolio, including houses, jewels, EPF/PPF, etc to get
an accurate picture of your asset allocation.
● Investing is more a business of risk management than finding [greater] returns.
● Mind the behaviour gap, and do not chase returns.
● Debt part of your portfolio is for providing stability; don’t go looking for returns
there.
● More money is made by choosing the correct asset allocation and sticking to it
than picking the right stocks or funds.
● Making money is a factor of how disciplined you are. Most people underrate the
discipline part of investing.