Tejinder Singh Rawal's Blog

Mutual funds are proxy vehicles. Since you do not have the time or resources to research stocks and to keep track of your investments on a day-to-day basis, you trust a third party, which is regulated by the government (SEBI) and which employs managers with professional qualifications. This gives you confidence, and you believe the judgement of a pinstripe-coat-wearing professional from a top B-school with an excellent ability to manipulate the spreadsheet will be superior to that of yours. Mutual funds also save you from the stress associated with the stock market, the anxiety of watching daily price movements.
Unfortunately, all this does not result in higher returns to the investor because:
1. Most mutual funds under-perform in the market. Track the stock market index and track the average mutual fund; you’ll find that mutual funds do not keep pace. Put in simple words, if you buy the index (either directly putting all index shares in the basket or buying an index fund which invests only in the index), you will make more money than the money that comes from the intervention of professional money managers with a high IQ.
2. Few fund managers can afford to swim against the current. If a sector is languishing and is considered a bad investment by most brokers, it may be a great investment idea for you but not for the fund manager. Even if he knows it is a tempting idea, if he buys it and it shows no growth in the next quarter or the quarter after that, his credibility as an analyst will be at stake. A stock which is out of favour may remain out of favour for many quarters and years. He must buy a share that does not show contrary trends in the short term, else he faces the music.
If he discovers a stock that is a true hidden gem lying in the dust of small-caps or mid-caps, barely noticed by the market, can he lap it and wait for it to turn into a multi-bagger? In all probabilities, he cannot. Many of such investments may take a long time to fructify; some of them may not grow at all, but if one out of ten becomes a ten-bagger, it takes care of ten that did not grow. Since the timeline for the maturation of these investments is obscure, no fund manager can take the risk of facing the music when his investment drags the fund value down. So what does he do? He’ll buy the likes of Tata Steel or Asian Paints or ACC. This won’t raise the eyebrows, and if ACC falls, he does not lose his job. Nobody will question the buy decision; they may even ask, ‘What is wrong with ACC?’
The greatest tribute to the amateur investors is paid by the manager of one of the largest funds, Peter Lynch when he says he continues to think like an amateur as frequently as possible.
3. Some funds may impress you with the track record of a particular scheme; know that the statistics are deceptive. There are 11,000 schemes in the market, and the annual return on these schemes vary from −20% to +50%. (This is randomised. One year with +50% does not mean that next year it will be the same scheme with 50%; it might be another scheme.) It is easy for any fund manager to pick a few good schemes that have delivered a great return for a couple of years. This is called ‘survivorship bias’ (i.e. the logical error of concentrating on the people or things that made it past some selection process and overlooking those that did not because of their lack of visibility). It is easier to showcase your best ware, keeping the ugly ones wrapped under the carpet.
4. Some people try to avoid this survivorship bias by diversifying among mutual funds, which is buying 10 different schemes instead of 1. Know that with 11,000 schemes in existence, all chasing a few scrips, this diversification is an exercise in futility.
5. Mutual funds can’t beat the market because with assets of ₹10,52,757 crores (as of March 2015, that’s the latest figure the Association of Mutual Funds in India has on its website). They are the market.
6. The high cost of running the funds is the main factor why funds cannot beat the market. As explained above, funds are managed by people of high calibre. However, the administrative cost of running the funds often drags the revenue down. An investor in equity can directly invest 100% of his investible money.
7. There is always the fear of redemption, and funds need to provide for that. Most people get panicky when the market falls, and when they should up their holding, they withdraw. In contrast, most of the money that becomes available to fund managers is when the markets are in a state of euphoria. They are forced to buy high and sell low.
8. Some funds indulge in dubious practices. UTI is the extreme example; things have improved since then but not completely corrected. Performance of fund managers is traced quarter on quarter and year on year. He must deliver at every reporting period. If the performance remains depressed, the fund manager often resorts to unethical practices, like selling loss-making investments at the end of a quarter so that it does not show as a blot in the statements. Window dressing is also common in order to show financial information that’s better than the actual.
9. We do not have long-term statistics from India, so I will draw this conclusion from USA data, and I presume the conclusion does not change. US$10,000 invested for 40 years in Treasury bills (government bonds) returned $48,000. The same amount invested in bonds during the same period gave a return of $102,800; in average mutual funds, $212,000; and in S & P 50 (the stock market index), $650,000.
10. Most money managers get paid as a percentage of assets under management. They must expand the asset base to earn more incentives. The objectives of the money managers are not aligned to that of the retail clients.
11. Since the client is likely to shift away from the worst performing funds, fund managers try to remain within the average, under-perform the average, and the client moves away. There is no incentive to beat the average. By its very nature, fund business entails perfunctory performance.
The verdict is clear, mutual funds under-perform. If you can stay invested in equity for a long term, following the long-term investing principles, you are likely to get a market-beating return; if you are not confident of your abilities to handle it, go for index funds. Go for mutual funds only if you want to stay just above the government bonds’ rate of return.
The index fund is good for an average passive investor but not for those willing to work hard. Indexing has a fundamental flaw: it is self-defeating. The index is the vehicle of choice for the efficient market hypothesis followers, who believe that the index is more efficient than individual shares. If more and more people buy the index, the market should move towards a higher level of efficiency. Less and fewer people will now resort to fundamental and technical analysis. If every investor buys the index, the price of the share prices will never change in relation to each other because nobody will be left out to offer a different price, eliminating all mis-pricing. This will kill the stock market.
‘Mimicking the herd invites regression to the mean,’ as Charlie Munger would say. He means that if we buy index funds, we are content with the average. However good the index will do, you remain with the index, because you have chosen your investment vehicle to drive at an average speed. If you want to beat the average, drive a different vehicle.
(Dr. Tejinder Singh Rawal is the author of the best-selling book ‘Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation.’)

“The avoidance of taxes is the only intellectual pursuit that still carries any reward.”
John Maynard Keynes

It is important for you to know the correct tax implications of various transactions pertaining to stock market investment. Some people presume there are no taxes on stock market transactions. Some like to leave the complexities of taxation to the chartered accountant. Some just like to close their eyes to it (‘Not my cup of tea’). No doubt taxation in India is complex, yet taxation of securities is not complex, and the provisions are unambiguous. Since the tax is a cost to be factored in while calculating return on investments, it is important that you understand your taxes well. The government loves to present tax in a language incomprehensible to most of its subjects except a small tribe of tax experts. Let me hack it for you and present it in plain English.
The Income Tax Act likes to distinguish between an investor, a speculator, and a trader for tax treatment. If you are buying and selling shares intra-day (i.e. you square off your transactions without taking delivery), you are considered a speculator. If you buy and sell frequently, with each stock coming in and going out of your demat account, you may consider yourself a trader.
If you are an investor, income arising from the sale of your shares is considered as capital gains. Income from trading is considered business income. We will discuss the two categories and their subcategories.
First, investment income. Since you are reading this book, I presume, you are a long-term investor and are more interested in this section. Let us understand the taxability applicable to you as an investor. Tax depends upon the holding period (i.e. for how long you have held the share before selling it off). The government encourages long-term investment; you pay less tax when you hold a share for the long term. The law divides income from capital gains into (a) short-term capital gains and (b) long-term capital gains. Let us understand the two concepts.
The law has a simple definition of short term. An investment held for less than one year is considered a short-term investment, and investment held for more than a year is considered a long-term investment. This is fantastic from the point of view of investors. Since most of you will hold many of your investments way beyond one year, so your investments will fall in the category of long-term investment, qualifying for soft tax treatment.

Short-Term Capital Gains (STCG)
When the shares are sold within 12 months of their purchase, the profit on the sale of such shares is called the short-term capital gains and is taxed at a flat rate of 15%.
Here’s an example. I buy 100 shares of Maruti Suzuki on June 2018 for ₹6,000 a share and sell them off in November 2018 for ₹6,800. The short-term capital gains will be:
Sale price ₹6,80,000
Purchase price ₹6,00,000
Short-term capital gains ₹80,000
Tax at 15% ₹12,000
Please keep a couple of things in mind:
1. Short-term capital gains are taxed at a flat rate of 15%. This is likely to be lower than the rate at which your other income is taxable. Of course, this is higher than the tax on long-term capital gains. Still, tax at 15% may be considered quite a low rate of taxes. My wish is that the readers of this book change their investment strategy and stay invested for the long term so they pay even fewer taxes than this.
2. This concession on short-term capital gains is available only to a special class of assets, which includes equity shares. The concession is not available regarding other class of assets (for example, land, and machines) where tax treatment is different.
3. The law requires that this concessional treatment is available only if the securities transactions tax (STT) has been paid on the sale of such shares. STT is the tax that your broker collects from you when you sell your shares through him. It implies that your shares are being sold through a stock exchange in India (your contract note from the broker will show details of STT paid) and are not off-market transactions or sale against buy-back offer by the company, in which cases this concessional treatment will not be available to you.
Let us now consider the long-term capital gains.

Long-Term Capital Gains (LTCG)
Long-term capital gains arise when you hold your investments for over one year. The rate of tax on capital gains is 10%, but the effective tax rate is likely to be much lower, for the reasons explained below.
• If the capital gains during the year are less than ₹1,00,000, there will be no tax. LTCG up to ₹1,00,000 is exempt from tax.
• If your LTCG is ₹1,50,000, the tax will be payable on ₹50,000 alone after deducting the exemption of ₹1,00,000.
• On capital gains beyond ₹1,00,000, the law allows you concessions to reduce your liability further. Suppose you had bought 100 shares of Azko Nobel in 2015 for ₹1,000 a share and you sell them on November 2018 at ₹1,500 per share, the tax treatment will be as follows;
purchase price ₹1,00,000
sale price ₹1,50,000
There is a capital gain of ₹50,000 in the transaction, but as said before, let us explore the additional concessions available.
The law says for shares purchased before 31 January 2018 which are long-term capital assets (that is, held for over 12 months), you have an option of substituting the price as of 31 January 2018 instead of the purchase price. Let us say the price on 31 January 2018 is ₹1,200.
Now the figures change as below:
purchase price (deemed) ₹1,20,000
sale price ₹1,50,000
Voila! The capital gain has been reduced to ₹30,000 now instead of ₹50,000.
The rate of tax being 10%, your tax will be ₹3,000. If you have sold no other shares during the year, there will be no tax; the exemption of ₹1,00,000 will take care of that.
Please keep these in mind:
1. As explained earlier, the concessional treatment will be available only if the STT has been paid on the transaction.
2. This special treatment is available to equity shares and some special assets alone.
Let us now consider taxability where income is not considered a capital gain but as a business income.
A. Income from intraday trading. Income from intraday trading is considered as a speculative business income. If you buy in the morning and sell in the afternoon or if you sell in the morning and buy it back in the evening, the income is considered a speculative business income.
B. Income from futures and options (F & O). F & O may be speculative instruments from the point of view of readers of this book; however, tax laws do not consider them speculative because some people use F & O for hedging. So they may be legitimate, non-speculative transactions (though, I suspect, the lawmakers want to promote F & O, thus this special treatment).
Income from the speculative and the non-speculative businesses is clubbed together and added to your income and charged to tax at the normal rate. The rate of tax depends upon your income slab and can vary from 0% to 30%. The only difference between the income from a speculative business and the income from a non-speculative business is that losses arising out of the speculative business (to recall, intraday trading) cannot be set off against the income arising out of the non-speculative business (that is, F & O). In short, they discourage intraday trading but not F & O.

Tax on Dividends
Dividends received from an Indian company are tax-free. The company is required to pay a dividend distribution tax before it pays you a dividend. As far as an investor is concerned, whatever he gets from his investments as the dividend is exempt from tax.
However, in the case of a resident individual/HUF/firm, the dividend shall be chargeable to tax at 10% if the aggregate amount of the dividend received from a domestic company during the year exceeds ₹10,00,000. Thus, if you receive ₹12 lakhs as dividends, after deducting the exemption of ₹10 lakhs, the remaining 2 lakhs will be put to tax at 10%, and the total tax will be ₹20,000.
Note that dividends received from foreign companies are taxable.

Tax Is an Important Variable to Consider
Having understood the taxability of investment income, let us delve deeper into it. This book is about long-term investment and discourages speculation and short-term investments. Our investment periods are 5, 10, 20, or 30 years—or even a lifetime. So not many of your transactions will fall under taxation for trading and for short-term capital gains. Only a few would come in the category of short-term capital gains; for example, you buy a stock only to discover later that your fundamental assumptions were wrong, so you need to sell them. In my investing life of more than 30 years, I have not earned a single rupee from either speculative or non-speculative trading. I hope you also emulate my example.
Dividends are a welcome source of income, and the best part is, it comes tax-free. However, the dividend payout ratio of good companies is low. Whatever you get is tax-free, but you get little.
Let us talk about the tax we all are concerned with: the tax on long-term capital gains. The tax rate is 10%. This 10% tax is payable when you sell your shares. If you are following the investment philosophy explained in this book, you will sell your shares after holding them for many, many years. The liability arises at the exit point. It means as your capital continues to appreciate, you pay no tax. You can watch your investment turn into a ten-bagger or a multi-bagger. Without paying a cipher penny as the tax. Only when you sell it will the liability be attracted. If you understand the time value of money, the liability paid ten years from now has very little monetary value now. Your effective rate of taxation thus comes to a ridiculously low figure.
A short-term investor pays a high tax. First, the rate of tax to a short-term investor can range from 15% to 30%, depending upon whether he is a speculator or a short-term investor. Second, the tax is required to be paid in advance or during the year in which he earns it. Thus, his outflow is higher, and it’s earlier. This reduces the funds available to him for compounding, reducing the overall return.
STT is also a major dent on the corpus of a short-term investor. The short-termer trades frequently, and he pays higher STT since the STT is to be paid on every contract note. The long-term investor buys far too infrequently and sells even less infrequently. Thus, he saves a lot from STT. STT is to be paid upfront on every transaction, and thus it reduces the investible funds, resulting in lower compounding. One often-ignored component is the brokerage paid on transactions. The brokerage curve runs parallel to the STT curve, and the more frequently you trade, the more money you make for your broker. When you trade frequently, you deserve a letter of appreciation from two sets of people you toil for: the government and your broker.

(Dr. Tejinder Singh Rawal is the author of the best-selling book ‘Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation.’)

If you want to have a better performance than the crowd, you must do things differently from the crowd.
John Templeton

Think Big
Most of the people who have made it big could do so because they knew they could do it; they believed they could do it. Many of us refuse to tune to the right channel. We don’t dream ourselves wealthy; the obvious result is that we never grow rich because we never planned for it. You need to condition your mind into believing you are wealthy and successful. This is the precondition: unless you believe you can do it, you can’t do it.
If you are waiting for a lottery or a windfall, you are wasting your energies. Lottery creates riches sometimes, but it would be folly to wait for the heavens to select you from out of billions. And even if you are the lucky one, historical evidence proves that few who became rich by winning a lottery sustained the riches. It’s an unviable proposition: the probability of winning is bleak, and if you win, you may not keep that wealth for long since you have not trained your mind in the art of making and keeping wealth.

Set Your Goals
A fool and his money are soon parted because a fool does not define his goals. Unless you define where you want to go, you will never reach it. This is very important. Set your goals. You need to create your own mission statement and then, based on such a statement, define your goals, both long term, and short term. Your goals should be quantifiable. ‘I want to be rich’ is not a defined goal. (Doesn’t everyone want to be rich?) ‘I want to have a net worth of ₹1 million by the age of 30’ is a goal.
While the former is just a wish, the latter put a quantified value to it, and you can measure your performance as you move towards achieving your goal. The best way to define and quantify your goal is to write it down. Write it down clearly and unambiguously as if you are writing work specifications.
Set the goal that will make you exert yourself. If you set your target too low, it will fail to be an effective motivation. Your goal should cause a little discomfort, a little stress, which produces positive results. It should be realistic, though it must be set a notch higher than your present capability. Setting a goal that is far too unrealistic will defeat the purpose. If you are setting an impossible goal, you are likely to throw it out the window sooner than later.

Read and Reread Your Goals Periodically
Compare the actual results with the projected. See how you are faring. If you are performing better than expected, is it time to revise your targets upwards? If you are performing poorly, are things going fundamentally wrong, or do you need to lower your expectations?

Do Not Have Too Many Goals
Setting too many goals may confuse you, and you may lose focus. Goals may often contradict each other and may lead to dilemma situations. Keep them simple, keep them short, and keep them limited to the things you want.

Your Goal Should Be Measurable
You should be able to track and measure your progress. They should be tangible. You should be able to visualise them. If you can visualise something, the chances of success are higher. Abstract goals get lost in oblivion.

Find a Mentor
It is very important for you to associate yourself with people who are rich and successful. Being in the company of successful people will give you positive energy and the motivation to succeed. Surround yourself with people who are failures, and you are also likely to become one. Mix with successful people; it will provide you the micronutrients that will build your inner strength to succeed. ‘It’s better to hang out with people better than you. Pick out associates whose behaviour is better than yours, and you’ll drift in that direction,’ says Warren Buffett.
Why will someone agree to be your mentor? It is a lot easier than you imagine. You may find a mentor, and you may ask him you want to succeed and you want to emulate his ways. Many will oblige. In fact, you will be surprised to find how many people are eager to help. Few people come forward to ask for genuine guidance, so if asked, you are likely to get it with pleasure. I have mentored many, and I know mentoring gives as much satisfaction to the mentor as it gives to the mentee.
If you cannot find an ‘active mentor’, you can find a ‘passive mentor’, a successful person you follow without that person knowing or caring about it. This way you can get free mentoring from some of the most successful people in the world.
In the Hindu epic Mahabharata, Ekalavya is a young prince of the Nishadha tribes and a member of a low caste. He aspires to study archery in the gurukul of Dronacharya. After being rejected by Dronacharya, Ekalavya embarks upon a programme of self-study in the presence of a clay image of Dronacharya. He becomes the best archer in the world, with his skill far superior that of Arjuna, Dronacharya’s favourite and most accomplished pupil.
Read biographies of successful people like Buffett and Gates. Read everything about them; find out the principles from their lives you can emulate. How about writing an email to a successful person, appreciating his work? Genuine admiration is bound to be appreciated.
Do not despise rich and wealthy men. Some people hold strong negative notions about wealth and find fault with the man who has made it big. The successful man is considered a product of luck, fortune, or ill-gotten wealth. It need not be so in a majority of cases. Stop fretting and fuming about wealth and appreciate the success of people who have made it. Take pleasure in the success of others, appreciate it, and tell them you like it. Genuine approbations never go waste.
Surround yourself with successful people. Remember, you are the average of five people who spend the most time with you. Join clubs, associations, chambers of commerce, and other bodies where you are likely to come across successful people.
Don’t let people around you divert you from your goals. Stay away from negative influences. There will be many people around you who will discourage you, laugh at you, and try to convince you that what you are up to is impossible to achieve. They will try to drag you down to their own level of perfunctory performance. Please stay away from naysayers and doubting Thomases.

Know How to Manage Your Money
The skill of managing your money is equally important, if not more important than earning it. ‘The art is not in making money but in keeping it’ (Chinese proverb). Create wealth consciousness. Fortunes have been withered away because people failed to manage their money well. Rich people don’t have a higher IQ than poor people; they are just good in the art of managing money.
You may argue, how could you manage your money when you don’t have any? Don’t put the cart before the horse. The money management skills must be learnt before you earn big money, not after that. When you have less money, you can experiment more, or you can try different rules—not so when the kitty is big. It is like learning to swim in the toddlers’ pool before you try your swimming skills in the ocean. The ocean is unforgiving; the little pool is forgiving and friendly. Managing your money is more important than the amount of money being managed.

Record Your Transactions
If you want to be a successful investor, it is imperative that you keep a meticulous record of your transactions. You don’t have to be an accountant to know how to maintain accounts. You can create a simple spreadsheet with receipts in one column and payments in another. You can find software like QuickBooks or Peachtree to do it for you. Those who hate the electronic world might maintain a simple diary to record their financial transactions. A crash course in basic accounting is desirable, though not a precondition, to maintaining your accounts. If Warren Buffett, with billions of dollars of wealth that he manages, still handles his own accounts, can’t we take the lead?
Double-entry bookkeeping is a wonderful system of keeping accounts; it was invented in the fifteenth century by Luca Pacioli. A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.
Financial information used to be recorded in books (hence bookkeeping), whereas now it’s recorded mainly in computer systems. These books were called ledgers, and each transaction was recorded twice (hence, double-entry), with the two transactions being called a debit and a credit.
The accounting equation serves as an error detection system: if at any point, the sum of debits does not equal the corresponding sum of credits, an error has occurred. It follows that the sum of debits and credits must be zero. The system is self-balancing and is like a modern management information system in that the ‘trial balance’ is thrown out of balance if you do not record the double effects of a transaction.
While accounting is seemingly a mundane task, knowledge of accounting will stand you in good stead in your pursuit of wealth.

Pay Yourself First
Many people know this simple trick, but few practise it. You earn and you pay others until nothing is left for yourself. And you postpone your share to the next cycle. In the next cycle, there are more dues to be paid. This goes on and on. The stage when you have enough surpluses to pay yourself first will seldom arise. Parkinson’s second law, ‘Expenditures rise to meet income’, keeps operating against you.
The best solution is to pay a ‘salary’ to yourself every month. This has to be set aside first before you pay others. You may think this may not work for you since your spending always exceeds your inflows. Prioritisation of resources is a matter of attitude and habit. You must start learning to prioritise when the resources are less, not when you have an abundance of resources. You can make money, or you can make excuses, but you cannot make both.

“Never Spend Your Money Before You Have It” (Thomas Jefferson)
Generation Z, so appropriately called digital natives, takes pride in living on borrowed money. Plastic money has created havoc. Credit card companies will make the spending power available at your doorstep even if you don’t need it. It will entice you to spend, spend, spend, spend without even owning money. We are a part of a massive consumption-oriented economy, where success is measured in terms of how much you spend rather than how much you earn. The result is obvious: we recently saw the unprecedented sub-prime crisis in the West, which threatened to kill the financial system of the entire world.
Spending money before earning is like counting your chickens before they hatch. What if they don’t hatch? You start creating a bubble, thinking that the future is rosy and bright. But things seldom work out the way you think they will. The bubble grows bigger and bigger, and you start borrowing in order to service the past debts. The situation worsens when your borrowing is spent in paying off the interest of earlier loans. You cannot afford to do so for long unless you are a government! Charles Dickens puts it so effectively in David Copperfield: ‘Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.’
The only reason a great many people don’t own an elephant is that they have never been offered an elephant for ₹1,000 down and easy weekly payments.
If you want to be rich, take a vow: ‘Thou shall live within thy means.’ Come what may. This is a sine qua non. Ignore the future. A more conservative and desirable stand is to keep in mind all future expenditure but not to consider future income unless it comes into your bank account. Do not borrow. Not that rich people don’t borrow. Borrowed money does give leverage, but you will be better off not borrowing. Borrowing in any form is ruled out. No overdrafts, no credit card borrowings, no leveraged trading, no futures and options, no intraday trading.

Be Fully Committed to Creating Wealth
Everyone wants to be rich, but very few make it. There is a big difference between wish and commitment. Being rich requires a definite commitment, a pledge, a vow, a promise to yourself that you shall be rich, that you shall remain focused to your goal of creating wealth, and that no matter what your present station in life is, you shall attain a comfortable position. This dedication is necessary. Wealth is created in your mind first, and the material wealth follows.

Use Your Internal GPS System
Define your goals, lay down the road map, and keep driving towards your destination, mile after mile, never losing focus. If you have a clearly defined plan imprinted in your mind and a strong commitment to the fulfilment of the plan, the internal GPS system takes over and drives you to the destination, undeterred by diversions and speed breakers. If you keep reminding yourself of your goals constantly and develop a habit of not deviating from it, you set in motion the internal autopilot. You just watch things happen on their own, with no efforts on your part!

Let Your Money Work Hard for You
Most people work hard for the money. Smart people make money work hard for them. If you work hard for money, there is a limit to which you can go. The limit is defined by your intellectual ability, your courage, your competence, and a host of other factors. But when you let your money work for you, you make your money make more money for you. And more money makes still more money. And so on. It breeds like rabbits and keeps breeding at a fast pace. Set aside as much money as you can so that it can be your rabbit farm—a small rabbit farm initially and will eventually grow exponentially. You can sit, relax, and enjoy the fruits of success. This game is better than FarmVille since you breed actual rabbits and not the ‘e-rabbits’ that FarmVille produces.
If you invest your money wisely in the stock market, you are actually participating in the dynamic economy. You are part owner of a business that works 24/7, creating wealth for all owners like you. The money works when you are sleeping or playing golf or are on a long vacation to the Far East. Its work is not related to your mood, nor does it stop working for you when you are sick. Compare this to the money that you earn by expending your own labour. The quantum of money you can earn is limited by many obvious factors.

Do Not Panic
Have courage and belief in your own self and in your investment methodology. Things are likely to go wrong. That should not deter you. If you do your homework well, an adverse situation can be turned into an opportunity. When investing in the market, things do go crazy. Mr Market behaves irrationally quite frequently, and irrational exuberance is often a rule rather than an exception. It requires wisdom to understand the market and courage to face the adversity. Be greedy when others are fearful and fearful when others are greedy. Remember this success mantra; it will always help you when you face the rough weather.
The strategy explained here is defensive. The author knows well that if things can go wrong, they will.

Just Do It!
The time to act is now. Buckle up and get going. Money has a time value. If you start earning, saving, and investing early, you have already doubled your money before your friend even started investing. Procrastination is the thief of time, and time is money.
(Dr. Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

How Much to Diversify Your Portfolio?
“Always keep your portfolio and your risk at your own individual comfortable sleeping point.”
-Mario Gabelli

When you carry only one stock in your portfolio, you’ve put all your eggs in one basket. Any fall in the price of the scrip will hit you. If your software export company is quoted at ₹100 and the auditor of the company qualifies the financial statements, as a knee-jerk reaction, your scrip falls to ₹80. One remark has wiped off 20% of your capital. The solution is to diversify. However, not all risks can be mitigated by diversification.
While diversification may help you mitigate the specific risk, it does not mitigate the market risk. The specific risk is peculiar to a company or a small group of companies. Workers’ unrest leading to the closure of the Tuticorin plant of Sterlite Industries is an example of a specific risk. The good news is that the specific risk is diversifiable. Statistics say just by owning 2 stocks, you have eliminated the specific risk of owning 1 stock by 46%; 4 stocks will reduce your risk by 72%; 16 stocks by 93%; and 500 stocks by 99%.
It does not matter if the above statistics are accurate or not; however, they bring out an important principle. As you move from 1 stock to 2, you reduce the risk. Moving up with every stock added to your portfolio, the specific risk reduces, but beyond a number, around 20 stocks, the gain is not substantial. Thus, while owning 500 stocks will nearly eliminate your specific risk, it will not be a prudent thing to do. Let us see why.
While buying 2 stocks instead of 1 has reduced your risk by 46%, it has also reduced the reward ratio to that extent. Taking the example further, if a sudden improvement in the results of your stock causes the price to rise by ₹20, your gains on a ₹100 stock will be 20%. However, if you have diversified into another company and are now holding 1 share of the other company that’s, let us say, priced again at ₹100, a rise of ₹20 in the price of your first stock will now translate into a 10% gain in your portfolio instead of 20%.
Diversification is desirable as long as the mitigation of risk arising out of diversification outweighs the dilution in appreciation that may happen because of diversification. A number between 10 and 20, depending upon your risk appetite and the sectors and the company you invest in, should be an optimum diversification. The tendency of most investors is to diversify so much that their portfolio looks like a miniature model of the whole market, a poor strategy. Worse, when diversification is in inferior-quality stocks, the basket only has rotten apples and will under-perform even the indices and may be called ‘diworsification’.
Diversification does not mitigate market risk. Market risk is the possibility of a loss occurring to an investor which is caused by the performance of the overall market. Market risk is the systematic risk in the sense that it affects the entire system. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters, and terrorist attacks. This risk cannot be eliminated though it can be hedged against.

Templeton versus Buffett
The successful investor Sir John Templeton says, ‘Diversify. In stocks and bonds, as in much else, there is safety in numbers.’ Equally successful investor Warren Buffett takes the opposite view and says, ‘Wide diversification is only required when investors do not understand what they are doing.’
Buffett quoted Mark Twain: ‘Behold, the fool saith, “Put not all thine eggs in the one basket”—which is but a matter of saying, “Scatter your money and your attention”; but the wise man saith, “Put all your eggs in the one basket and—WATCH THAT BASKET.”’
Other successful investors like George Soros, William J. O’Neil, and Bernard Baruch are also known to recommend a concentrated position.
Charlie Munger says, ‘This worshipping at the altar of diversification, I think that is really crazy.’ Munger discovered that if we can find companies with great economics that continue to grow year on year, creating an additional margin of safety on the go, we must concentrate on them. That way, we may reduce the number of companies to ten. ‘You should remember that good ideas are rare,’ he would say. ‘When the odds are greatly in your favour, bet heavily.’
So what’s the right approach? Buffett himself recommends that passive investors who do not have the time or inclination to research the stocks will be better off by investing in indices. An index is nothing but a bundle of shares, so investing in indices means a broad diversification. This may look like a contradiction, but it is not. If you can understand the business so well, you can trust all your eggs in that basket. You may do that, but if you do not, spread them in different baskets. Investors like Warren Buffett have the acumen and resources to know a business inside out and can afford less diversification, but for retail investors, what we discussed earlier sounds logical, diversifying in about 20 stocks.
Diversify less, and you must have the acumen to watch that basket carefully. One rotten egg and the valuation is severely impaired. A one-star performer may bring about fantastic returns on your investment. This approach is more suitable to larger investors, who have resources to attend to each of the conference calls of companies they own and can keep track of every single piece of information concerning those companies.
If you diversify too broadly, as explained above, you are becoming something similar to the index, and your chance of beating the index is bleak. If you diversify too much, it becomes impossible to keep track of the updates pertaining to each of the stocks you own, and you end up becoming a passive investor, a mirror of the index fund. Diversification to the extent of around 20 companies is ideal. You may track each company. Reading 20 financial statements every year and as many results, every quarter is no big deal and is easily doable.
My strategy is to buy about 20 stocks in unrelated sectors. When one sector (let us say technology) is on the rise, the speculators would often square up their holdings in another sector which seems slow (let us call it FMCG) and pour it over the momentum. This fuels a further rise in the technology sector, causing a fall in FMCG. When the reversal of trend happens, the money will flow out of technology and get into some another sector that is rising. Diversification across sectors provides a balance against this sectoral bias. Since we invest in a few securities, the number of companies we invest in must be evenly distributed across sectors, though sometimes we may find two or three companies in a particular sector which are attractive investments.
To sum up the discussion, diversification is a matter of individual choice. More knowledgeable investors may diversify less. An average investor should diversify sufficiently, say 20 stocks, to mitigate the effect of a couple of bad investments.

(Dr. Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

The stock market has more than its fair share of myths and misconceptions. People with varied backgrounds enter the market, a few with a clear idea about how the market operates. People who win a lottery ticket or have received a large bequeathal or some windfall head towards Dalal Street to make their money grow further. The fool parts with his money too soon, and he is left with a bitter experience about the market and is ready to spread the market myths. Let us debunk the stock market myths.

1. You Have to Be a Genius to Make Money on the Stock Market
People who lose money on the stock market believe they do not have the requisite level of intelligence to make money. Professional money managers are also happy to spread this myth. Unless you have a Ph.D. in finance and unless you have training in handling complex mathematical equations, the stock market is not for you, they advice. Your money will grow better with them, they claim.
This is far from being true. Investment is nothing but common sense. You don’t have to be an economist to invest; just being smart enough not to make stupid mistakes will suffice. What investment requires in abundance is discipline, and if you lack that, you fail as an investor. Let me reiterate: you don’t have to be a genius to succeed in the stock market. You need the right discipline, the right attitude, and should know how to control your emotions and stay focused on long-term goals.

2. You Need a Lot of Money to Be in the Market
A popular misconception is that the stock market is for rich people and you need a lot of money to enter the market. This myth is responsible for domestic savings not being channelled into the market. The stock market could change the fate of many who can raise their station in life and realise their financial dreams. I hope to see more people from the middle and lower-middle strata of society to invest. This can be a better poverty alleviation programme than the government-sponsored plans and can uplift the masses and the economy to a faster growth track. The stock market could be a panacea to the financial woes of individuals and the economy. I wish every citizen who has a bank account also has a demat account.
The entry to the stock market is easy and cheap. It costs almost nothing to open a trading account. You can buy stocks for as low as ₹500, and you can buy them as and when you have the money.

3. Investing Is a Time-Consuming Process
You have perhaps watched a friend (let’s call him Mr. Speculator) glued to the screen the whole day, with his blood pressure mimicking the price chart of stocks on his screen. He must have his breakfast before the market opens and cannot have his lunch (perhaps a vada pav or a Bombay sandwich since that is what you can eat with one hand while operating the computer with the other) till 3.30 p.m. when the market closes for the day. He seems to be in a war zone, switching stocks on his screens, buying and selling at a frantic pace.
Looking at him, you conclude that the stock market is not your cup of tea and that if the way he does things is what it’s like to be in the stock market, then it’s better that it is not your cup of tea.
The investment we are advocating is a different world. Mr. Speculator buys and sells dozens of scrips in a day; he may buy the same scrip again half an hour after selling it. He may sell something he does not own, intending to square up the transaction before the close of the market.
You as an investor will buy the same number of scrips during your entire lifetime that Mr. Speculator buys during a day—maybe 20, 30, or 50 scrips at the max. You don’t have to watch the screen or CNBC every day. The less you watch, the better it will be for your financial health. If you can presume that the market has closed down for the next five years after you have made your purchases, you will be better off. Your research (unlike that of Mr. Speculator) is real research and is restricted to the companies you own or the companies on your wish list. It may look boring to an onlooker. True investment is boring and unglamorous. There is more money to be made by inactivity rather than activity.

4. Pay a Professional Instead of Investing on Your Own
This is another myth professionals are happy to perpetuate. It has been proven repeatedly by research and empirical evidence that amateurs beat the professionals in investing. Have the mindset of an investor and invest on your own. The entry and exit load, administrative expenses, company policies, and limitations on the category and type of investment that a fund can buy make the professional investment too restrictive and less profitable than the systematic amateur investor.

5. For Higher Returns, You Must Take More Risk
This comes straight from economic theories. It sounds rational that the higher rewards will come only if you will take higher risks. This belief propels people into speculation as a quick road to success; on the other end of the spectrum are people who are content with bank deposits because they think investing in equity is risky, and they cannot afford to take risks.
Both extremes are misconstrued. I have explained elsewhere, and let me reiterate, equity is the safest investment class as a long-term investment. The longer you hold it, the safer it becomes. When you hold equity long enough, the risk-reward ratio axis of equity intersects that of bonds (which people presume to be the safest), and beyond that point, equity is safer than bonds. The keyword is long term. Long-term investors are defensive players. The first thing they think of is protecting their capital. They know that rule number 1 is not to lose money.

6. History Repeats Itself
People look for patterns; they like to believe past trends will recur. A stock that has risen will fall, and because it has fallen, it will rise again. All these hypotheses are with no basis and believing them is an exercise in futility. Trends are often nothing more than pseudo correlations. Even when a trend has a basis, past trends do not guarantee a projected outcome. If a stock rises for three days in a row, it does not mean it will rise on the fourth day too or that since it has risen for three days, it should fall on the fourth day (known in the market as a three-day running streak). It is the equivalent of saying that since three consecutive outcomes of throwing a coin have been a head, the fourth one has to be a head again (or the fourth one has to be a tail). The coin has no memory, nor does the market have any.
If it has gone down low, it can’t go lower—this is another aspect of this history myth. To explain how fallacious it can be, let us consider Vakrangee Ltd, a software company. On 21 December 2017, the company declared a 1: 1 bonus. The shares were trading at ₹380; the price rose to a high of ₹515 on 25 January 2018 and fell from the peak. It fell to ₹202 on 7 February 2018 and had a small bounce back. Many investors (technicians, traders, speculators included) would have said, ‘It has gone low, it can’t go lower.’ And there was a fresh interest in the script, taking the price to ₹280 on 20 March. It was an uptrend. Going by the principles of technical analysis, it was a welcome move; however, the rally could not sustain, and it fell again. The current price of Vakrangee stock is ₹22! If you had paid ₹515 on 25 January 2018 to buy a share, your money has vanished, and the price as of November 15 is ₹22. How much lower can it go from here? Well, my answer is, you may lose ₹22 at the max on this share because share price cannot go below zero.
Consider Kwality Ltd, a food-processing company whose shares fell from ₹160 in March 2017 to ₹7.50 on 15 November 2018 (having the name Kwality does not make it a quality stock). Or consider a stock which was once the darling of all operators in the stock exchange: Suzlon Energy. The company was said to revolutionise power generation and distribution by manufacturing and selling wind turbines and was said to be the largest producer of such turbines in the world. The profits are all gone with the wind, and the present market price is ₹5.70. Crores of rupees of the wealth of investors have vanished into thin air.
I am giving you these examples to caution you against buying on tips, buying without sufficient research, and buying without enquiring into the quality of management. Good companies will come back. Bad companies won’t.
If history repeats itself in the stock market, it is randomness. The market does not bother about what the price was yesterday or the day before. The price is determined by the interaction of forces of demand and supply, which are influenced by a host of factors—some rational, some irrational. When the irrational factors outweigh the rational ones, the price moves away from value, though in the long run, it comes back to touch the value line often. Do not bother about history repeating or not repeating itself. Buy when there is a favourable mis-pricing and sell when the price is realised or when the mis-pricing takes price above the valuations. Or if you have selected the stocks that grow to create an additional margin of safety, you may hold them forever.

7. Buy Low, Sell High
This is fantastic advice, easy to understand. But can you apply this in practice? Can you know how low is low and how high is high? As discussed above, no low is low, and it can go further down until it reaches a ridiculously low figure. Trying to catch the bottom of a falling share is like catching a falling knife. A falling knife can quickly rebound in what’s known as a whipsaw, or the stock may lose all of its value. Buying low is wishful thinking; it may not happen in practice. If you sell high, the price may go higher, and you may feel the pinch of the ‘loss of profit’.
The solution is to buy a quality stock at an attractive price, ignoring the market direction, and to have trust in your investment method. Review the assumptions periodically and monitor your holdings.
You cannot time the market. There is one exception to this: there are times of gross irrational exuberances when the prices are driven to either dizzying heights or ridiculously low bottoms. That is the time you should sell or buy. Most successful investors remain invested when the crisis falls on the market and sell off substantial holdings and sit on cash when the market reaches a crazy high. This is the exact opposite of what speculators do. They panic and sell at the bottom, and they buy frantically at the top. ‘Buy low, sell high’ is observed more in its breach.

8. It Has Touched a Lifetime High; It Can’t Go Further Up
This misconception does not let people grow rich in the stock market. Shares have unlimited potentials of growth. If you have invested in a company that grows, you have to sit back and relax and watch your company make money for you. The sky is the limit as to how high your stocks can grow.

9. It Is Only ₹4 a Share; It Can’t Go Down from Here
New investors who do not understand the nuances of the market feel that since they are beginners with less money to invest, they should buy stocks that are selling cheap so they can buy more shares out of the same money. Human thinking is far from rational. We are happier buying 1,000 shares of a company selling at ₹4 a share rather than buying a solid-growth stock selling at ₹4,000 each. The common thinking is that a ₹4 stock may not fall. It’s already too low. But if it rises, it will rise faster compared to a ₹4,000 stock. I have heard investors say many times that ‘high-priced’ stocks are for institutions and large investors and ‘low-priced’ stocks are for people like us.
There was a time when this was true to a limited extent. When shares were sold in physical forms, the stock exchange used to specify the minimum order quantity. It was known as the market lot. You had to purchase in the multiple of the market lot. This made some shares beyond the reach of small investors, and they would stick to stocks which were selling cheap. The legacy thinking continues, though there is no market lot any longer and you can now buy just one share. I often buy shares worth ₹1,000 in companies I think could be my potential future investments so I can track them. If you own even one share, you are not likely to lose track of that company. What is out of sight gets out of mind.
It is folly to call a ₹4 stock cheap and a ₹4,000 stock expensive. Stock is cheap or expensive vis-à-vis its value. A ₹4,000 stock may be undervalued; a ₹4 stock may be overvalued. When the market falls, an undervalued ₹4,000 stock is likely to fall less, say 20% or 30%, but a ₹4 stock may come down to zero even when the market is not falling. It may have come down to ₹4 because the company may be heading towards bankruptcy. If it falls, your entire capital gets wiped off. If a stock goes to zero, it does not matter if you bought it for ₹4 or ₹40 or ₹4,000, your loss is exactly the same: 100%.
There is another problem with a ₹4 stock. Since this liquidity of such stocks is low, there may not be any buyers when you want to sell them.
I know of investors out there who claim to have made 10,000% profits by buying a stock at ₹3 and selling it at ₹300. What they won’t tell you is that one out of 100 stocks rose from ₹3 to ₹300, while most other stocks they own have no buyers.
These shares rise fast and fall faster, and the rise is momentum driven with no change in fundamentals. Our advice is to stay away from them unless you find a margin of safety in them.

10. I Will Sell It When I Break-Even
I have seen this happen to most of us. If I buy something at ₹100 and it falls to ₹70, I wait till it goes back to ₹100 again, and if it goes back to ₹100 and I sell it, I feel I have done a great job. Cognitive psychologists call this phenomenon ‘loss aversion’. If you sell at ₹70, losing ₹30 hurts you more than the happiness that a gain of ₹30 will bring to you. Loss aversion implies that you lose more satisfaction from a ₹100 loss than the satisfaction you get from a ₹100 gain. This irrational behaviour is well documented in behavioural economics.
What should be the right approach? If it falls after you buy it, revisit your notes and the assumptions you relied on for making the buy decision in the first place. Are the assumptions still valid, or have you made a fundamental mistake? Is there a change in circumstances that has led to the fall, something you could not have expected earlier or not known earlier? Is the fall not related to any fundamental factors but to market irrationality?
If a change in fundamentals has eroded the intrinsic value of the stock, causing a permanent loss to its value, it is futile to wait for the price to come back to ₹100. Blame it on luck or whatever and get out of the stock. The stock might never see ₹100 again, and if at all it comes back to that again, it may take so long that the cost to wait may be more than the appreciation. Loss aversion ignores the time value of money. When you sell a stock languishing at ₹70 at ₹100 after six years, you are happy to have broken even. You don’t realise that during the six-year period if invested the right way, your money would have doubled.
If the fall is for reasons other than the fundamentals of the company and the intrinsic value of the stock is intact, it is time to buy more at ₹70. I follow a golden rule. If a stock has fallen and I am tempted to wait for the break-even price, I put myself to a test: am I willing to buy more at ₹70? If the answer to this is no, I do not want to hold the share for a single day. If the answer to the question is in the affirmative, I will not only hold it but will put all my available money to buy more of the same stock.
Remember an important rule: stock price has no memory; it does not care for who you are and at what price you bought a share. A stock does not know you own it. The stock market has no compassion; it does not care if you took a loan to buy a share at ₹100 and now the price is ₹70. You buy at the prevailing price, and you sell at the prevailing price. The market is what the dictionary defines it to be: a place to buy and sell.

11. If It Has Gone Up after I Bought It, I Am Right
This is behavioural economics irrationality, and even professionals fall prey to this myth. If you buy a share and it rises after that, you feel it like confirmation by the market of your buying decision. If it falls after you buy it, you suspect your own decision. If you are a day trader or a speculator looking for a quick gain, an immediate rise after you buy may be a cause of cheers for you. To an investor who is buying a stock to hold it for ten years, does it matter? Short-term volatility and price fluctuations are not for you; the market might swing in either direction. Remember, it is thanks to volatility and mispricing that you bought that investment. Market price at any point in time results from the equilibrium between the forces of demand and supply. The market does not take into consideration the fact that you had bought 100 shares of a company at ₹100 last month during the trade-off between the forces of demand and supply.

(Dr. Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

A stock split is a decision made by the company management to split the shares into multiple shares. A company may split its ₹10 shares to two shares of ₹5 each. Companies resort to a split when the price per share has gone beyond the range deemed appropriate by investors. It is a pure psychological game. An investor is likely to feel a share trading at ₹2,000 (face value ₹100) more expensive than a share trading at ₹150 (face value ₹5). He does not understand that a share with a face value of ₹5 is trading at 30 times the face value, while the other one is trading at 20 times. We often end up comparing apples to oranges.
Investors often greet the stock split decision with extreme joy, and the price rises after the split. The reasons are more in human psychology than in economics. Speaking logically, a split should not add any value. When a company which has 1 crore shares of ₹10 each splits its shares into ₹5, it would now have 2 crore shares of ₹5 each. The pizza remains the same. Instead of splitting it into 4 slices, you split it into 8 slices. Now there are more slices; perhaps more people can share it. It’s the same with the stock split. Earlier, I held 500 shares; now I have 1,000 shares. I am likely to be tempted to sell the ‘additional’ 500 that I received because of the split (even though it is nothing more than splitting the pizza slice). This generates more floating stock in the market at an affordable price. More floating stock and lower price—the market is likely to receive it favourably.
When a split happens, the trading price of the share is adjusted in the markets. Thus, a share trading at ₹100, when split in two, should trade at ₹50. However, as shown above, cognitive factors often drive the price higher.
Some people like to buy the shares on the split announcement and sell them after the split. There is no real unlocking of value in the split, so it is a non-event as far as a value investor is concerned. Split changes none of the economics of the share; it remains the same share, just cut into a lower denomination. Knowing a split is often welcome by investors, unscrupulous managements often resort to stock splits at the peak of the boom so that the psychology keeps driving their stock prices higher, though prudent management would also resort to the stock split to keep the price in the range. Some of these companies have split so many times that the face value is now ₹1. A split less than ₹1 is not permissible.
There are notable companies which understand that split creates no real value. In the present market scenarios, institutional investors dominate the market. A split is inconsequential to them. A split is of no consequence to retail investors too since there is no marketable lot in a digital environment and you are free to buy just one share. Unless the price of one share itself is beyond your reach, Berkshire Hathaway has never split its shares, and the price is beyond the reach of many. On the date of writing this, I checked up Berkshire’s price, and it was trading at $15,525 (₹3,23,935). In 1996, with Berkshire Hathaway selling for $33,000 a share, outsiders planned to buy Berkshire shares and resell them to investors in $1,000 pieces through unit investment trusts. Not wanting small investors to pay sales charges and other administrative expenses that such trusts would entail, Berkshire Hathaway issued class B shares (dubbed Baby Berkshires) each without voting rights and worth 1/30 of the regular class A shares. In January 2010, they split class B shares 50 to 1, making each worth 1/1,500 the value of class A shares. The latest trading price of Berkshire B is $9.67.
In the Indian markets, the current trading price of MRF is ₹65,129 (face value ₹10), Page Industries ₹29,650 (FV ₹10), 3M India ₹19,440 (FV ₹10), Eicher Motors ₹22,500 (FV ₹10).

(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

The news of the issuance of bonus shares brings cheer to the investors. Companies like to reward the shareholders without affecting the cash flows. Investors like to invest in companies that give bonus shares. They consider bonus shares a sign of good health of the company.
Let us understand how the bonus shares work. Bonus shares are issued out of the accumulated profits of the company. The accumulated profits belong to the shareholders, and when not issued as bonus shares, they are still a part of the book value of the shares.
An example will help us understand. A company has issued 10,000 equity shares of ₹10 each. Thus, the total paid-up capital is ₹100,000. The company has accumulated profits (also known as reserves and surplus) of ₹500,000. Thus, the total monies belonging to shareholders is ₹600,000, or ₹60 per share. The company utilises ₹100,000 out of the accumulated profits to issue bonus shares at the ratio of one share against one share held (1: 1) The total capital is now ₹200,000, and the accumulated profits are ₹400,000. You now have two shares instead of the one you owned before. The book value of each share is ₹30 per share, and since you own two shares against each held before, the total book value of the original share plus bonus share put together is ₹60. As you can see, it created no real wealth. The claim of one share was ₹60; now you own two shares. The claim of two shares put together is ₹60. The proportionate right of a shareholder has not changed.
The issue of bonus shares does not impact the profitability of the company in that bonus shares are akin to a stock split; the only difference is that the split changes the face value. Instead of one share of ₹10, now you have two shares of ₹5. The bonus creates additional shares. Instead of one share of ₹10, you now have two shares of ₹10 each. There is no difference in the bundle of rights and obligations.
There is another difference important for an investor to recognise. A company can split shares any time; it need not be backed by any reserves. It is akin to changing a ₹10 note for two ₹5 notes. Bonus shares can be issued out of accumulated profits alone, which means the company needs to have sufficient reserves before it capitalises them as bonus shares.
On the issue of bonus shares, as the shares become ex-bonus, the market price adjusts to the new price. For instance, a company trading at ₹100 issues a 2: 3 bonus. (This means two new shares against three held by a shareholder.) For ₹300, a shareholder that had three shares earlier now owns five shares. Thus, the stock should now trade at ₹60 per share.
Does the price rise after the bonus announcement? It does. The reasons are not psychological as with a split. Let us explore the reasons.
1. The rise in liquidity brings more floating stock. Some people feel they have ‘free’ shares now. It is positive for the investors. Higher floating stock is often correlated with price.
2. Bonus shares are issued out of reserves; it is a celebration of the success of the company. It is a confirmation to the investors that the company is successful.
3. A very important reason that a bonus is important from the point of long-term investors has to do with future payouts. A stable or increasing rate of dividends is what most investors look for in companies as a measure of stability and growth. There is a certain amount of ‘stickiness’ in the dividend that companies pay out. A constant rate of dividends assures the shareholders that all is well with the company. If a company reduces dividends, it sends bad signals to the investors. A company which pays out an increasing rate of dividends must continue to do so. If it does not increase the payout in a particular year, the market becomes alarmed. Company managements are particular not to cause any scepticism by changing the dividends policy.
When a company issues bonus shares, the total share capital is increased to that extent. Keeping the same rate of dividends means paying out more. Dividends being sticky is, in most cases, a corporate policy; a bonus implies a higher amount of dividends in the future.
This is one factor which makes the bonus superior to splits from the point of view of shareholders. A split is often a gimmick to boost the share prices in the short run; bonus shares are long-term commitments.

(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

“No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant.”
Warren Buffett

‘The investor’s chief problem—and even his worst enemy—is likely to be himself,’ says Warren Buffett. Investment is as much about psychology as it is about economics. People often fail in the former. World-class economists don’t make world-class investors. Many of them are the worst performers. Investment success depends on the mental make-up of the investor combined with technical competence.
Few know Albert Einstein invested much of his 1921 Nobel Prize money in stock markets. However, he lost bulk in the stock market crash in 1929. Einstein was awarded 121,572.54 in Swedish kronor for his Nobel Prize in Physics, which was equivalent to over twelve years’ income for Albert Einstein back then. He lost almost all of it and realised that his Nobel Prize-winning wisdom was not suitable for winning in the stock market. The stock market requires a different temperament. (Later, Einstein remarked that the power of compound interest is the most powerful force on earth.)
You are your worst enemy. Frenzy, exuberance and excesses in the market, dubious companies with window-dressed balance sheets, a sudden change in domestic and international macros may not harm you as much as your own temperament.

Patience
The most important trait that an investor ought to have is patience. No matter how technically sound you are, you are likely to face rough weather. The market will go down, your investment will under-perform for quite some time, and unless you have inculcated the virtue of patience, you are likely to sell at the wrong time. Lack of patience makes people do dumb things with their money.
Greed and fear are two dominating forces in the market, and unless you have trained your senses to stay disciplined in the face of such extreme market behaviours, you are likely to succumb. Factors that distinguish Warren Buffett, Charlie Munger and Peter Lynch from other investors are the tremendous patience and discipline they have.
Buffett says he would be happy if the stock markets closed for ten years after he bought his investments so he would have no means to track his investments while they continued to grow. It requires nothing less than Job’s patience to hold on to your investment when the market forces are against it—and a great deal of conviction in your investment philosophy.
Munger says, ‘You have to be patient, wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.’ We are not out in the market, looking for investments; we are just waiting for the right investments which we have identified as having become available to us at the right price. Till the price comes to the level that gives enough margin of safety, we wait, with our ears and eyes wide open. We keep reading everything about the potential investment. The day the right investment becomes available to us at the price we wanted to buy it, we buy like crazy.

Investing Is Not Cricket
In cricket, the batsman must hit every ball that is bowled to him. If he does not, either the ball hits the stumps, or if he obstructs the stumps with his body, it will be an LBW. He has to decide at every ball how to play so he remains at the crease for a longer time and can score well when he can hit the sweet spot. The player remains under tremendous pressure, the cheering and shouting of spectators adding to the confusion.
The intelligent investor does not invest like the intelligent cricketer plays cricket. He has an advantage over the cricketer. He need not play every ball. He can decide not to play a ball he does not understand, and it has no penalty point. He can wait for a favourable ball to come, and he can hit that ball with full force.
Warren Buffett used the baseball analogy to explain this point. He says, ‘The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling “Swing, you bum!” ignore them.’ Buffett only invests in companies that are within his ‘circle of competence,” a concept he first described in his 1996 shareholder letter. ‘You don’t have to be an expert on every company or even many,’ he says. ‘You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.’
If you stick to what you know, you would never go wrong. You don’t have to buy every stock that looks interesting to you. You should have the ability to filter out the noise and focus on the companies you can understand. Because of your education, experience, interest, research, and passion, you might have developed expertise in certain industries. Sticking to those industries would make your investment safe. You may ignore the Infosyses and Wipros if you do not understand the technology. They may be great investment ideas, but they are not for you.
Buffet says the size of your circle of competence is also not very important. Even a narrow circle is big enough to filter out the required portfolio size for you. However, an intelligent investor is a lifetime student. He keeps widening his circle of competence.
When students asked Buffett’s advice on how to get rich, he would say, ‘I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.’
If you decide that you have to hit only 20 balls during your entire investing career and there is no penalty for not playing a ball, you will be as careful as you can. You will buy only those companies you can understand well; else you will not hold it for a day.
If you look at the Indian market scene, it is opposite to this. People are burning off their energies and monies buying and selling stocks they don’t understand at the drop of a hat. They perhaps bought them on tips and would sell them when they need money for buying another tip. At the end of the year, when they draw the accounts for the year, they find that while they have been moving at a frantic pace, they’ve travelled no distance. They end up making more money for intermediaries through commission than for themselves. We need a disciplined, systematised approach towards stock market investing.
The market is dominated by untrained traders who do not know how to control their emotions. Alternating bouts of greed and fear decide a trader’s investment patterns. When buying a mobile phone, he carries out a vast amount of research about the megapixels of the camera and the GB in the RAM and battery life. When investing, he leaves it on Mr Market to decide for him. If he were to spend half as time on his lakhs of rupees worth of investment as he spends on buying a ₹20,000 mobile phone, he would be much better off. He fails to see the stock as a share in the business and looks at it as a money-making proposition. I hope every investor reads this book to train his mind in the right way to invest.

Insulation
The investor needs to inculcate the talent to turn out the noise. Tune in to CNBC, and you’ll see tickers moving up and down, trying to capture every news and every piece of rumour. More often than not, the ‘information’ is mere noise, with no effect on the fundamentals of the stock. The recent failure of IL&FS created panic waves in the market, and all NBFC shares went tumbling down. When the market reacts, it overreacts. Shutting down noise will make you rise much above the average investor whose buy and sell decisions are impacted by short-term noises in the market. Some people don’t want to miss a single piece of chatter and stay glued to the screen all day long. In the connected world, information travels fast, and misinformation travels faster. A single WhatsApp message can bring a company down. (A recent example is Infibeam; one message caused a 70% fall in price.) And a single Tweet may make the stock soar. (A recent example is Elon Musk tweeting about Tesla getting international funding.) The reaction is often disproportionate to the financial implication of the news. (Efficient market hypothesis proponents would frown.)

Focus
The ability to stay on course in the face of conflicting signals is an important winning trait. Staying on course is a close cousin of patience, and intelligent investors are known not to deviate. The average investor digresses from the course because he doesn’t even know what path he has chosen. He does not define his investment goals. If you do not know where you want to go, you can never reach it. Hundreds of distractions coming his way every day are likely to make him sell when he should buy and vice versa.
The ability to stay calm in the face of a storm makes you a successful investor. When there is blood in the market, most people are seen running for cover. The intelligent investor stays calm and unperturbed and tries to find value in the market. During frenzy, people who stay calm are likely to discover great investments, while others seem to be feeling the heat.

Do Your Homework
The intelligent investor remains patient and calm and does not succumb to noise and stays on course because of an important trait he possesses: he does his homework well. He knows why he has made a particular investment. He studies every quarterly result, half-yearly result, and annual results of the company he has invested in to know the original premise he based his decisions on are still valid; and if it is no longer valid, does it call for a change in decision? Experience suggests that if you have done your homework well and are satisfied with the fundamentals of the company, in a majority of cases, you are likely to find a reinforcement of your belief in subsequent events.
In a few cases, you are likely to see the fundamentals deteriorate. However, if the fundamentals of one company you have invested in deteriorate beyond repair, you might consider exiting it. Selling at this point also requires a calm mind: if fundamentals have gone off the mark, the intelligent investor would exit the scrip, while the frenzy investor would wait for the share to come back to a particular price so he recovers his losses, which may prove to be a futile exercise.
The intelligent investor rarely sells his investment unless he needs money or unless he finds that fundamental assumptions are no longer valid. And when he sells it, he remains indifferent to the profit or loss made in the transaction. To him, the latter situation is nothing more than plucking out the weeds so that the rest of the farm may grow better.

(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

The best time to plant a tree was 20 years ago. The second best time is now.
Chinese Proverb

As an adviser and mentor to many people, I am often asked to say in simple terms how to create great wealth. There is no secret formula involved here. It is no rocket science and is one of the easiest things to understand and learn. However, it is strange that not many do it. The formula is: start early. Start investing your money at the earliest; let the magic of compound interest create a sizeable wealth for you.
Though the price of real estate has come down considerably in recent times, for most Indians, buying a house remains a difficult financial decision. It may mean committing a substantial part of your future earnings also, especially if you are considering buying a property in one of the metro cities. Children’s education is an expensive affair these days, and depending on the stream chosen, it may leave you poorer by ₹50 lakhs or even more. Marriages continue to be expensive affairs in India, and people usually end up spending way beyond the justifiable limits. Add to this the contingencies, the medical emergencies, the lifestyle-related expenditure (tours abroad, phones, cars), and it looks like a big gap between saving and the required amount.
While it is a daunting task, it is achievable. Invest early—the earlier, the better—so that the multiplier of compound interest can multiply your capital many times over. Once it gets going, the magic is unstoppable: ₹1 becomes ₹2, ₹2 becomes ₹4, ₹4 become ₹8 . . . And soon your money grows at an astonishing rate of growth even when invested in securities that grow at a low annual rate of growth.
A young professional who has just started his career will find low investible surplus, and he would think it is better to spend that small sum instead of investing it, as small savings might not contribute much to his long-term corpus requirement. This is the biggest mistake he could make. Sow the seed early, water it regularly, and I assure you, the crop you reap will be stupendous. It will be higher than the return of his friend who starts later even if the latter invests more money.
Most people procrastinate. Some are inspired by the ‘eat, drink, and be merry’ philosophy, while many others remain ignorant. People don’t know what they could have done with their money. They don’t realise their investment options until it is too late and until it spirals into a crisis. A typical procrastinator may be seen discussing the macroeconomic situation which is ‘grim’, ‘recessionary’, ‘bleak’, or ‘terrible’ and is waiting for the situation to improve so he can invest. If he is not concerned about the macro-parameters, he is not able to decide on which stock to invest in. He sits on cash which earns zero return in absolute terms (and negative return when inflation is considered) or burns cash since there is no worthwhile investment vehicle available.
Investing early has interesting consequences for you. You may retire early while your colleagues are still struggling to make ends meet. Even if you reduce the contribution at a later stage of your life, it may not make a significant difference to your corpus, which will have grown to an impressive figure by then. Your twenty-year-old tree will have developed enough roots and branches to stand on its own by then.
Some readers may realise their folly but will have already lost precious time. The lost time cannot be regained. What then is the optimum solution for you? To make up for the lost time, you will now need to invest a larger quantum. You may have to curtail certain expenditures or increase your sources of income to match up the pace of the tortoise that started slow and steady twenty or thirty years back and is now way ahead of you in the race.
Einstein is said to have called compound interest the eighth wonder of the world and said, ‘Those who understand it earn it, and those who don’t pay it.’ For the magic of compound interest to work, the baseline needs to reach a certain scale. Compounding is parabolic. The longer the time you give for the base to build, the higher it will take you. Few people have enough patience or foresight to realise this. If you want the magic of compound interest to work for you, you must start at the earliest and build the base early so that the ball gets rolling on its own. If you have understood the importance of compounding in the early stage of your career, nothing can stop you from becoming rich. Even a modest income, if invested and stays invested for a long period, can make you wealthy beyond imagination.
Warren Buffett gives the example of the Mona Lisa to explain the power of compounding. King Francis I of France had asked Leonardo da Vinci to paint the Mona Lisa at a cost of $20,000. It holds the Guinness world record for the highest known insurance valuation in history at $100 million in 1962. This figure looks astounding until you consider that if $20,000 had been invested at 6% per annum, it would have grown to $1 quadrillion by 1962; that’s 3,000 times the national debt. He says, ‘If Francis had kept his feet on the ground and he (and his trustees) had been able to find a 6% after-tax investment, the estate now would be worth something over $1,000,000,000,000,000. That’s $1 quadrillion or over 3,000 times the present national debt, all from 6%. I trust this will end all discussion in our household about any purchase or paintings qualifying as an investment. However, as I pointed out last year, there are other morals to be drawn here. One is the wisdom of living a long time. The other impressive factor is the swing produced by relatively small changes in the rate of compound.’
In 1987 when I started my practice, I had purchased two computers with MS-DOS operating system from Wipro for ₹45,000. (For those who are curious to know, one of them had two floppy drives and no hard disk. You put the operating system floppy in drive A, and the data and application floppy in drive B. The other one had a floppy drive and, thankfully, a 10 MB hard disk. The computers had a 128 KB RAM.) If instead of buying the computers, I had bought Wipro shares for ₹45,000, they would have been worth more than ₹400 crores now, after considering the bonus, splits, dividends, and price rise! That is the loss of profit!

(Dr Tejinder Singh Rawal is the author of the bestselling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

Thank You Mr Speculator
I am often asked this question by people who do not understand the intricacies of the market. Whenever people lose money, they echo these sentiments. On 11 October 2018, Sensex fell by over 1,000 points, and the Economic Times reported that investors lost a wealth of ₹4 lakh crore in 5 minutes. The blood on the street belongs to the speculators and not the investors. And when they spilt blood, often you heard that speculation should be ‘banned’.
Such sentiments are often expressed in the commodities market too. When the oil prices rise, all fingers point at speculation, and people blame the government for creating infrastructure for speculators to indulge in excessive speculation.
It looks so obvious. If something is so bad, should the government not declare it illegal? Well, the simple answer is, speculation is not at all bad for the market. Speculation may make the speculator an overnight king or a pauper since he wins big and loses big, yet it performs important economic functions for the market. The presence of speculators helps, not hinders, the attainment of perfection in the market. Let us try to understand what at first sight looks like a paradox.
As discussed earlier, speculation is the practice of engaging in risky financial transactions to profit from short-term fluctuations in the market price of a security rather than attempting to profit from the underlying financial attributes embodied in instruments such as capital gains, dividends, or interest.
Speculators pay little attention to the fundamental value of a security and instead focus on price movements. In doing so, they perform a host of economic functions.



1. Price Stabilisation Function
While this applies to commodities and securities, it will be easier to understand it as it applies to commodities. The economist Nicholas Kaldor has long recognised the price-stabilising role of speculators, who even out ‘price fluctuations due to changes in the conditions of demand or supply’.
The speculator and hedge fund manager Victor Niederhoffer has beautifully explained it thus:
Let’s consider some principles that explain the causes of shortages and surpluses and the role of speculators. When a harvest is too small to satisfy consumption at its normal rate, speculators come in, hoping to profit from the scarcity by buying. Their purchases raise the price, thereby checking consumption so that the smaller supply will last longer. Producers encouraged by the high price further lessen the shortage by growing or importing to reduce the shortage. On the other side, when the price is higher than the speculators think the facts warrant, they sell. This reduces prices, encouraging consumption and exports and helping to reduce the surplus.
The speculator is an opportunist. He makes hay while the sun shines. He makes money by filling the gap. Speculators, along with arbitrageurs and hedgers, keep exploiting the price gap. This leads to a more perfect market with more logical pricing. Contrary to what we believe, speculation helps price stabilisation in the long run. In the short run, speculation may cause hiccups in the market, but that is a part of the long-term stabilisation process.

2. Providing Liquidity to the Market
Another important service that a speculator provides to the market is, in risking his capital, he creates liquidity. Let us understand why this is so important.
We shall again use the example of a commodity since it is easier to understand. We consider a thinly traded commodity on NCDEX (which is the commodities market in India), say guar gum. Guar gum is an extract derived from guar seeds and is used as a natural thickener, emulsifier, stabiliser, bonding agent, etc. A chemical manufacturer who wants to buy guar gum goes to the market, but he may find no seller since the trades are not frequent. When a seller of guar gum wants to sell, there may not be enough buyers. In the former case, the buyer will have to pay a premium over the normal price since there is not as much quantity up for sale as the demand. In the latter case, the seller is likely to get a lower price. This price difference, known as the spread, occurs because there are not enough numbers of buyers and sellers at the same point in time. The speculator (an opportunist) will buy or sell any commodity where he finds the spread is large. He is risking his capital and filling the gap. Since a speculator often works with leveraged money, he can buy as much as ten times the actual buyer and can sell as much without owning a piece (thanks to the futures market).
With the market filled with a mix of investors (or actual users in the commodities market), hedgers, arbitrageurs, and speculators, you can imagine how much the volume will increase. It may be as high as 100 times the actual trade. (In the stock market and in the commodities market, you can find out how many of the deals are being settled for ‘delivery’ and how many are being ‘rolled over’.) The presence of numerous players leads to greater market efficiency. The greater quantity being traded lowers the spread, thus helping both buyers and sellers. It may sound ridiculous, but in tiny commodities like guar gum, the daily traded volume may sometimes be more than the annual production of the commodity!

3. Bearing Risks
A speculator loves risk; he earns his bread by taking risks. Sometimes he gets a cake to eat. Sometimes he sleeps on an empty stomach. He takes upon himself the risk that the seller or buyer of the commodity (or the investor in securities) would have been required to assume. A farmer can agree to sell his produce to a speculator in a forward market and can sleep knowing his produce has been pre-sold.
So much in praise of the hero of the market. And I am sure now you understand why you need speculators to help you succeed as an investor. Consider a hypothetical situation where every investor in the market is a clone of Warren Buffett. If everyone buys the mismatch between price and value, there will be no gap left soon, and once you reach the stage of equilibrium between value and price, there are no further profits to be made, except the profit arising out of the growth of the company. The equity market will have to be closed down since the uncertainty is gone. When all become Warren Buffett, Warren Buffett will be reduced to a purchaser of what looks like an equivalent of the government bond. Of course, this would never happen. Thank you, Mr Speculator.

(Dr. Tejinder Singh Rawal is the author of Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)

Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation