Hi guys! Welcome to the investing guru blog series for beginners. Today we are going to discuss if investing can make you rich. If yes then how? We will prove that with the calculations and historical data but first let’s start with a million-dollar question.
Can investing actually make you rich?
The answer is “Yes”, it definitely can.
But it won’t make you rich overnight contrary to what people expect.
People should understand that investing is not a lottery. Investing demands patience and time. If you are expecting returns overnight or over a month then it is called trading and not investing. In this blog, we’ll focus on investing. You have to stay invested for a very long time to become rich.
The longer you stay invested the richer you become.
Let’s understand it with the most basic formula of compound interest.
We all know,
A = Actual value of the investment after “n” years
P = Invested Amount
r = Interest rate per year
n = No. of years
As explained in the above formula, it is not the interest rate that will make you rich but it is the amount of time for which you stay invested will make you rich. But generally, people look for higher interest rates and disregard the importance of time in investing and hence disregarding the importance of compounding. Compounding is called the eight wonder of the world not for any other reason.
Let’s understand the power of compounding with the below examples:
- Case-1: An investor “A” invests one time Rs. 1 lac for 3 years and gets a compound annual growth rate of 50%.
- Case-2: An investor “B” invests one time Rs. 1 lac for 40 years and gets a compound annual growth rate of 15%.
Let’s see what investor “A” gets after 3 years
As we can see that the initial invested amount was Rs. 1 lac. Assuming that he gets 50% CAGR for 3 years and withdraws his money after 3 years, he will receive an amount of Rs. 3.37 lacs approx. on maturity. His investment amount got almost 3.4 times in 3 years which is a very good return. However, can we say that now the investor “A” has become rich?
The answer is “No”.
The truth is that the return he got is not going to change his lifestyle by much. Also, we have assumed that he will get 50% CAGR for 3 consecutive years which is a very very hypothetical case. Even the best of the best stocks give max around 30% CAGR and also there is no guarantee that the CAGR will be consistent for three consecutive years.
The selection of those stocks also requires a lot of brainstorming and there is no guarantee that the stocks you selected after brainstorming and analysis are going to give you the desired CAGR. In other words, the risk associated with this type of investment is very high. You may end up with 0 or minimal return if you invested in the wrong stock.
Take an example of Yes Bank. 2 years ago the stock price was around Rs. 400 and now it’s price has dipped to Rs. 25. I leave it up to you to calculate the loss you would have made if you had purchased the Yes bank stock 2 years ago.
Now, let’s see what investor “B” gets after 40 years
The initial investment amount is Rs 1 lac and we have assumed a CAGR of 15% per annum. From the above table, we can observe that after 40 years the investor “B” will get a whooping Rs. 2.67 Crores in return. Although the 2.67 crores after 40 years will not be the same as 2.67 crores now, it will be enough for you to live a luxurious life thereafter. If you stay invested for 5 more years then you will get Rs. 5.38 crores and so on. The longer you stay invested the richer you will become. Also, the assumed 15% CAGR rate is based on the historical data and is a reasonable one unlike the 50% CAGR rate considered for case-1.
What is the proof that you will get a 15% CAGR rate?
Let’s understand how Nifty has been doing since its inception.
We can observe from the graph that there have been several ups and downs in the Nifty. However, if you look for a long time interval then the Nifty has always been going up. If we look at the graph closely then we will find that the graph was almost a straight line until 2003. So, if we take our 1st reference point on 1st Jan 2003 and 2nd reference point on 1st Jan 2020 and calculate the CAGR (compound annual growth rate) for that period.
The value of the Nifty Index on 1st Jan 2003 – 1100
The value of the Nifty Index on 1st Jan 2020- 12182
Total Time Elapsed – 17 Yrs.
A= P x (1 + r/100)^n
12182 = 1100 x (1 + r/100)^17
r = 15.19 %
Apart from the CAGR, the companies also pay a dividend amount to the investors which accounts for around 1.5%. If we add that also to the CAGR rate then we will get an actual CAGR of around 16.5%. However, to make calculations simpler we have considered the CAGR to be 15%.
It implies that if you invest in Nifty for the long term then you should get a CAGR of about 15% based on the historical data. A CAGR of 15% is enough to make you rich if you are looking for a long term investment for 30 or more years. It should be noted that here we have considered only one-time investment. You can periodically invest a certain amount of money if you want to achieve your goals much earlier.
Now the next question is how can I invest in Nifty?
If you have gone through my previous blogs then you must be knowing that Nifty is an index of NSE and it is a basket of top 50 stocks of NSE based on Market Capitalization.
If you have not gone through my previous blog Basics of Indian Stock market, then I advise you to go through it.
Since Nifty is only an index and not a stock then how can one buy it?
Nifty is indeed only an index and it is not a stock which can be bought. However, there are index mutual funds that try to replicate the Nifty index by diversifying their portfolios in the same ratio as the Nifty index does for the top 50 stocks.
Thus, investing in an index mutual fund is equivalent to investing in the Nifty index. The risk associated with buying the Nifty index is much lower as compared to buying an individual stock. Investing in the Nifty index means you are investing in India’s economy.
In the long term, the economy is always going up. There may be 2-3 defaulters like Yes Bank in Nifty top 50 but the other 48-47 stocks will make sure that the Nifty index will always go up and so does your invested amount. Thus you need not worry if you are investing in the Nifty index as you are indirectly investing in the Indian economy.
Conclusion
So, we can conclude based on the above analysis and brainstorming that investing will make you rich if you stay invested for a long time. Time is the key to investing which most people ignore. We saw how a sustained investment even with a lesser CAGR for a longer period beats the short term investments with higher CAGR. My ultimate aim to post this blog is to make you aware of the importance of time and compounding in investing. With the hope that you will see the investing from a different angle from now onwards, I am bidding GoodBye!
If you have any queries/feedback then please post it below.
See you again in the next post!