Nilanjan Dey said savings rate, time, and net retention are the three rules for building wealth. He noted that everything else is just noise. Investors often get confused by complex market signals, but focusing on these simple factors helps. Saving more money is the best way to start growing wealth.
Savings rate, time and net retention decide wealth. Everything else is just noise, says Nilanjan Dey
Every edifice begins with a rock. A fine investment strategy begins with a plan. Despite the countless nuanced recommendations that relentlessly bombard him, an investor needs to figure out just three elements to place his foundation stone -- his savings rate, the time he can allow his wealth to compound, and his net retention after expenses, tax and inflation.
After you finish reading the opening paragraph, take a look around you. Our financial landscape is right now a crowded den of algorithmic signals. These convince us that wealth creation is necessarily a very complex puzzle to solve. It requires constant intervention and expert tweaking. A web of tactics is what we need to overcome the challenge.
No, that is not so. This Monday's argument should drive us to a rather different conclusion. We can scratch beneath perceived layers of complexity and arrive at a liberating truth. Financial freedom comes in the shape of understanding the three variables mentioned earlier. All the other things are either derivatives of these factors or marketing pitches aimed at vending savings and investment products.
Rate of savings
This can be easily identified as the very ground on which everything stands. The individual who saves the most can actually invest the most too. The clear emphasis here, mind you, is how much is being saved -- that is, the portion of income that is not being spent, and is earmarked for preserving. We celebrate the investor who can optimise his savings; yes, even if that means squeezing out an extra 5 per cent from his earnings over and above the normal.
* The gap between income and expenses is the raw capital that can be directed towards the compounding machine. We will come to it later.
* Investors will lose if they pay scant attention to the idea of "saving more" -- whopping returns on a small amount of money saved will still be small, right?
* Ultimately, and this usually happens in the very long run, our savings rate will influence our returns too.
* It so happens that most investors can exercise some kind of control on this variable. We have absolutely no say in government policy, we can never influence the markets. Yet we can alter our lifestyle (agreed, only to a limited extent these days!) to cut down on expenses.
Time to compound
Success in investment is by and large a function of time. The venerable Warren Buffett is not simply a great investor -- he has remained so for about three-quarters of a century! Ergo, time is our "secret sauce" although there is nothing quite secretive about the concept.
In the initial years, the average investor will probably be unhappy with sluggish growth and choppy returns.
Compounding over long periods will make a big difference. His performance curve is very likely to slope upwards over 15, 20, 25 years.
Time acts like a lever, and eventually the profits generated on earlier returns will begin to eclipse the basic capital he had originally contributed.
A patient individual with a decent capital profile over, say, 25 years is likely to be way wealthier than a quirky investor who desperately tries to score stellar returns yet manages to sustain his streak for merely five years.
Net retention
As investors, nominal gross performance of our assets should not be our goal. Period. A proud claim -- say a 15 per cent score -- must go through the grind. There are expenses and income tax to consider. And, finally, there is inflation, our worst enemy. Therefore, net retention is the only number that will determine our purchasing power in future.
* Our fixed deposits typically earn 7 per cent these days. Considering inflation that runs at about 4 per cent, we are not left with much. The impact of income tax ensures further erosion. This actually means most of our traditional fixed-income instruments are losing us significantly more than what we think. At any rate, our net resources are not growing enough.
* Short term capital gains, we must add, must be closely monitored. These are taxed heavily. As things stand, there are very limited means of saving taxes in India.
* If you are a relatively young person at the start of your career (thus, with sufficient time to spare) your savings rate is expected to be modest. But you can afford to invest in risky asset classes. These, quite naturally, will be volatile. Yet the same assets are likely to beat inflation over time.
* Now, if you have started somewhat later in life, while in mid-career perhaps, you should focus primarily on increasing your savings rate. This must be high enough so as to make up for lost years.
At the end, let us point out that the impact of high gross returns will always be marred by inefficient tax management. We cannot always spend what we earn. On the contrary, we can only spend what we manage to retain.