How much your money grows when you invest is determined primarily by 5 variables. Master them and you can grow your wealth many times over. The five variables are:
#1 Your annual investment return
This is the rate at which your entire wealth portfolio grows – so it includes all your assets – mutual funds, stocks, gold, FDs etc. This much is obvious that higher the rate of return, the faster your wealth grows. For some assets the rate of return is assured (FDs) while for others it is market linked (stocks, ETFs etc). A lot of mis-selling and risk seeking happens in figuring out ways to generate higher rates of returns using backtests and thematic baskets. Some instruments like Mutual Funds show audited returns – NAV is true return earned by investors in past. Some like thematic baskets are unaudited – they are paper returns. Use your judgement on who to trust.
#2 Your investment time horizon
The longer you invest the higher the final corpus. Few people understand the impact of compounding. An asset that returns 14% p.a will double in value in ~5 years. In 10 years it is ~4x and in 20 years it is ~16x. What may not be intuitive is that the last 5 years add 8x the amount of the first 5 years. The intuition here is clear – the sooner you start investing the longer your investment horizon can be to compound your wealth further.
#3 Taxes
Higher taxes erode wealth growth just as higher taxes erode income received. Tax rules can have significant implications. In India when mutual funds buy and sell securities to rebalance their portfolios they don’t have to pay any short term or long term capital gain taxes on it. An individual however has to pay 15% short term and 10% long term capital gain taxes for the same action. This increases the bar for thematic basket or trading portfolio returns to compete with mutual funds.
#4 Costs
Different investment instruments come with different transactions and other cost structures. Mutual funds charge a simple expense ratio that’s included in the fund NAV, the returns you see are net of cost returns. In trading and thematic returns you only know your gross returns – they are not net of multiple trading costs, bid offer spreads and capital gains as explained. Neither includes any financial planning or screener fee that you bear for your data and analytics needs. It also does not include the opportunity cost of your time being spent on stock and thematic basket selection compared to becoming better at your day job. Once you account for all your costs, you can get a good sense of how much you are leaving on the table in terms of future wealth growth. Usually the lowest cost investment instruments have the best long term wealth growth outcomes.
#5 The amount you invest
All else being equal, the more you invest the higher your final corpus. At a reasonable 12% p.a returns, a Rs 50 lakh investment can grow to Rs 7.6 Cr over 24 years. If you invest Rs 10 lakh only then you will have to take a lot of in-necessary risk to get a much higher ~20% p.a return to get to the same corpus. The easiest way to invest more is to earn more. And the easiest way to earn more is to be the best at your day job. Your human capital, via earned salaries, can really move the needle on your final wealth corpus.
Understand the five variables above and how they interact deeply and you can easily figure out how different market participants use them to sell you different products.
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