Warren Buffett, Carl Icahn, Ray Dalio, David Tepper, and Rakesh Jhunjhunwala are a few names who have moved up the value chain starting out from a very humble beginning.
If one looks at the examples of legendary investors globally, it can safely be concluded that it is entirely possible for a common man to become a millionaire through investing. Warren Buffett, Carl Icahn, Ray Dalio, David Tepper, and Rakesh Jhunjhunwala are a few names who have done remarkably well in the stock markets and almost all of them have moved up the value chain starting out from a very humble beginning. However, it should also be noted that the general perception about the markets in the masses is that investment in the equity markets is akin to gambling. To back it up, one can find numerous examples of retail investors who have lost their fortunes in the stock markets. One question that naturally comes to mind is that what separates the likes of a Warren Buffett and an ordinary investor? After all, both of them have access to the same markets and the same information. The closest possible answer, therefore, is the lack of financial discipline and a strategy to investing is perhaps the biggest difference between a legendary investor and an average investor.
Just by going through the past history of the markets, it can easily be said that the stock markets have a tremendous track record to help grow wealth for an investor. The S&P Sensex, for instance, has a historical annual growth rate of 15.86 per cent since its inception and has grown around 14.39% annually over the last 10 years.
The historical returns of a benchmark indices reflects the average performance of a basket of stocks that in some ways are reflective of the state of the economy of a country and various sectors that contribute to the economy. In reality over longer term some sectors would outperform and some sectors would underperform, but on an average equity returns have outperformed historical returns of any other asset class, be it Gold, Real Estate, Fixed Income or other alternative assets. Equity is perhaps the only asset class that has been able to deliver inflation-beating superlative returns on a consistent basis.
Returns from a benchmark index can appear to be muted to an extent given the fact that they reflect an average return of a combination of stocks. If one digs deeper and analyzes returns of individual good quality stocks, he/she would be absolutely convinced that investing in good quality stocks for a longer term horizon is a sure shot way to become a millionaire. For example, the following table presents the results of some bellwether stocks over a period of ten years, Bajaj Finance is one such example. If one had invested Rs 1 lakh to purchase a block of shares in Bajaj Finance Limited (BFL) 10 years back and holds till now, he’d be sitting on Rs 4.15 crore wealth in the form of BFL stocks apart from additional cash dividend received over the years. The stock has returned 82.73% annually and in 10-year time an investor would have had a growth of 41,400% on his investment in Bajaj Finance. Bajaj Finance is just one example. There are many other similar stocks which have provided stupendous returns to their investors over a longer term. Eicher Motors, Relaxo Footwears, Maruti Suzuki, Infosys, TCS are a few names that fall in that category.
In addition to finding good quality stocks in one’s investment portfolio one other critical component that is often overlooked is the power of compounding. The following table depicts the growth of a Rs 1 lakh investment over a period of 10 years and 20 years under different growth rates that are compounded over a period. In twenty years’ time an investment of Rs 1 lakh turns into Rs 6.7 lakh under a very moderate growth rate of 10%. If the growth rate, however, is 25%, the initial investment turns into Rs 87 lakh in 20 years. Therefore, it can safely be deduced that the recipe for long-term sustainable wealth creation lies in finding good quality growth stocks and to stay invested in them for a longer duration.
Recipe for Wealth Creation
So far we have established that equity investment serves as the best asset class over its peers over a longer duration of time. We have also identified that staying invested in good-quality stocks for longer durations is the sure shot way of wealth creation. However, why isn’t a common man able to create wealth in 10-20 years from the stock market? The reason is simple: most people do it the WRONG WAY.
By investing in the RIGHT WAY a common man can also become a millionaire. He/she just needs to focus on the two basic aspects to investing. First is the selection of right stocks and the second is to follow a few basic rules that make one a disciplined investor. For a common man, it is better to invest in only those companies that have a simple business model to understand, have very little debt, have free cash flows or do not have much capital expenditure. The most important thing is to look out for a business that has a capable and investor-friendly management. Investors should also research thoroughly about the company and invest only after the growth credentials of the company are firmly established.
However, having zeroed in with the right set of portfolio alone can’t make someone rich. To grow wealth, one also needs to follow a right investment approach. One needs to identify quality stocks and hold them tight for longer periods instead of involving oneself in short-term trading. A world-class company is built over the years and so is the wealth of an investor. An investor needs to develop the appetite to digest short-term disruptions. As Warren Buffett famously said, “The stock market is designed to transfer money from the impatient to the patient.”
Investors need to give time to their stocks to compound over a period. One should never try to time the market because catching the tops and bottoms is a myth. However, it is important to determine the correct price to enter a particular stock. Price comparisons should be made between a selected stock and it’s peers to establish the price attractiveness of your choice. Never let emotions drive one’s investment. Many investors have lost money in the stock markets due to their inability to control their emotions during market volatility. In a bull market, the lure of quick wealth is difficult to resist and in a bear phase it is difficult to tackle the loss.
Therefore, it becomes contingent to hold a stock based on its fundamentals instead of short-term market movements. In a bear phase instead of booking a loss and exiting a fundamentally good stock altogether, the strategy should be to put more money into the stock to bring your average cost of acquisition down and increase the probability of higher returns once the market normalizes. To be successful one should be realistic in one’s expectations and one needs to monitor one’s portfolio at regular intervals to ascertain that nothing fundamentally has changed in the stocks in one’s portfolio. If one finds stocks which have materially deviated from their fundamentals, the investor should not desist from liquidating those stocks from his portfolio.
Finally, becoming a millionaire by investing in the stock market or somewhere else is not out of the reach of a common investor. There are enough examples to prove this hypothesis. The success lies in hard work, careful planning and execution, and above all, a disciplined approach to investing for sustainable long-term wealth creation. Follow these things and become a rich person!
(By Rahul Agarwal, Director, Wealth Discovery/EZ Wealth)