Letter to my kid.

Dear Zohan,

I know you’re busy planning your next Minecraft fortress but let me teach you something that’ll change your life: investing. I know, so far (in your eyes) my biggest contribution in your life has been teaching you to dance down the wicket straight drive) but trust me, this life skill I am about to teach you is 10 fold more important. (unless u become a professional cricketer) So sit straight and listen up, I’m about to lay down the truth so you can create a robust financial plan.

Let’s start with a question, Zohan.

How much return is a good return? What to expect from your investments? Isn’t more the better?

I can best answer this by telling you a story my Guru Charlie Munger shared with the audience

Charlie was listening to his friend pitch a client about his portfolio management services and quoted and guaranteed an outlandish and crazy return figure, something like a 44% CAGR guaranteed.

Charlie confronted him and said, you surely cannot achieve such returns year on year, why would you promise such a figure.

His friend quipped, ‘that’s what client wants to hear, if not me, he will go to someone who quotes that!!!

Here is another example from old man.

“I was in Minnesota and I was buying a fishing lure. I looked at them and they were pink and green, and I asked the shopkeeper, ‘Do fish really take these lures?’ And the old-timer behind the counter said, ‘Mister, I don’t sell to fish.

SO, ANYTIME someone offers you an outlandish return, hold your purse and run. He is not telling the truth, he is tempting you and appealing to your greed. Remember the simple base rates. Inflation + country growth rate + reward for risk is all you can expect from equity investments. In the long run, you would be able to compound your money at 12–18% if you invest in index funds and factor funds. Anything more is a bonus you can accept gleefully!!!

If you decide to do it full time or find someone like uncle Daya, you should be happy with a 20–30% CAGR.

If someone offers you a fanatic number like 5% per month,(trust me, you will find many such crooks) simply do a reverse math and realize that compounding his own money like that, he can become a richest person in Delhi in no time, why would anyone need other people’s money if they could compound at that speed.

This is an Easiest heuristic to spot a fraud, surprisingly people twice or thrice your age are dumb enough to fall for this greed.

Keep it simple, set lower expectations. Index will fetch you 12–18% return and that is more than enough to become very rich.

Where will the Money come from.

Now that’s a good question coz by now you must have figured out that my money is NOT your money. You have to create your own corpus. The way to do that is answered by a friend of my Guru, Warren Buffett.

“If you buy things you do not need, soon you will have to sell things you need. The most important investment you can make is in yourself. If you’re in your 20s and 30s, save 30% of your income and invest it.”

So, the math's need to be reversed. Idiots the world over, Invest what is left after the expenses. You need to take out 30% of whatever you earn (invest it) and consider the remaining 70% as your take home salary. Doesn’t matter how much you earn, it’s a fixed percentage. If your starting salary in a humble start-up is 50k, you are investing 15k. If google has hired you for 1 crore a year, you are investing 30 lakhs every year.

This sounds simple but it is a very powerful reverse psychology. Its about PRIORTIES. Investing should have the FIRST right to your salary. Not your girlfriend, not your toys. Everything else need to adjust with the remaining 70%, period.

Where to Invest.

You know me, Zohan, I don’t just throw around opinions. I back it up with the facts. The SPIVA Report — which is basically the scoreboard of the investment world — shows that over the long term, active managers (the ones who claim to know how to pick stocks and “beat the market”) fail to do so consistently. Most of them are closet indexers unwilling to venture out due to career risk. This is true for Large caps so far, soon this will be true for mid and smallcaps as well. In US, (almost) none of the fund managers in any cap segment beat the MIGHTY INDEX.

Point is, if you are going to waste your time (bandwidth) in selecting a good fund manager, might as well go the full distance and pick stocks yourself and beat them BIG.

If stock market is not your life calling, I would suggest you to buy factor funds and index funds. A good exposure to momentum and quality and simple nifty next 50 will hold you in good stead.

What about the Downside

For any long term association, you need to have the buy-in for the worst downside.

SD

This holds true for both relationships and Investing.

At the start of the journey, you should exactly know how you would react when things go south. (and they will, it is not a question of if but when)

Ask your girlfriend, how she would feel/react when one fine day, you decide to quit your job and decide to start your business. She can ask you similarly, how would you react when one fine day, her mother decides to live with you guys ;))

If the worse downside you foresee is above the pain threshold, walk out of that arrangement. It cannot be a long term association.

Similarly in stock market, Pure vanilla Equity exposure will have drawdowns of 50–60% once in 10 years and 20–30% downfalls almost every 2–3 years.

If you think that is bigger than your pain threshold, you dilute your exposure with debt and gold. So say a 70/20/10 or even more sissy at 60/25/15.

Point is, for the relationship to be long term, it is MANDATORY for the pain to be below your threshold.

What is your pain threshold, I cannot say. This is something you will realize yourself as you experience life but usually it’s a lot lower than you think.

Insurance

Don’t buy Life insurance if you don’t have dependents. Buy it worth your opportunity cost if you do. Buy ONLY TERM Insurance.

Don’t mix insurance with investments, any product that mixes the two is just marketing gimmickry, you get duped from both sides. (horrible insurance cover and horrible returns).

Have more than adequate health insurance, home insurance. Insurance is like cheap OTM puts, you buy and write them off. They will protect you in event of a black swan or expire worthless.

Many a families come a strata down due to inadequate health insurance, you are 1 event away from losing everything you built. do not under estimate the increasing medical costs.

One last advice.

Avoid debt like you avoid creepers in your mindcraft game. The only loan that is worth taking is a home loan and even that requires a 10 year commitment which means sheer slavery, since you will be inheriting my house, I wud say you can avoid that as well, but I leave that to you. Any other loan is an easy NO. (except if your own company is taking it and claiming all kind of expenses and depreciation etc, that is a nuanced discussion for some other time)

With love and a whole lot of confidence in your future,

Your Dad,
Manish