Let’s do a thought experiment – Let’s say you are going on a multi-year cruise or journey around the world and need to invest your or your retired parent’s money. Let’s also assume that you want to ensure that the money is secure, but at the same time earns a decent rate of return (Which beats inflation).
Investments of this type should have the following characteristics
- The portfolio of such investments should be reasonably secure – low probability of long term loss of capital, though temporary fluctuations are fine
- Above average rate of return – The investments should beat the inflation and possibly earn a few percentage points above it, so that your family can withdraw a small portion of the capital without a reduction in principal
- Low maintenance – should not require your family or you to run around, doing tons of paperwork or other tasks to manage it
Let’s invert the question and look at what will not be good options
- Fixed deposit – Safe and low maintenance, but the rate of return barely beat inflation. As a result, if you use up the interest , the capital base will get eroded by inflation
- Real estate – May be secure and give above average returns, but requires constant work (maintenance, repair, payment of taxes etc). In addition, you cannot really invest small amounts of money into it.
- Gold – If you have been following me for sometime, you know my distaste for it. It is not an income producing asset and I cannot think of any family selling gold for meeting expenses – Remember the old Hindi films, where the family sells gold when it is in dire circumstances? We are too conditioned by those images.
I know you would have realized where I am going – equities!, but then not all types of equities. The above criteria eliminate some types of companies from the consideration set.
- New companies with a short operating history – Sure, the company is going to be the next titan or ITC (fill in the name), but if the companies goes down the drain while you are away then your family is in trouble
- Speculative companies – Loss making or penny stocks which have performed poorly in the past but have a very bright future.
- Companies with poor management – I don’t want to hand over my money to a crooked management who could cheat me in my absence (remember we are away for a long period of time)
If you think through all these options, you will realize that you are left with a small list of companies which meet the following criteria
- Durable competitive advantage – The company has done well in the past and you are assured that it will do well for a long period of time in your absence
- Good management – You can trust the management to be good caretakers of your money in your absence
- Reasonable prospects – The Company may not have phenomenal growth prospects, but should deliver above average growth.
If you put all these points together, I hope you can see a picture forming. We are talking of companies such as
A portfolio of such companies would be fairly safe as one is talking of good companies with above average economics and decent management. These companies may not be the next multi-bagger, but it is easy to see that they will give one a 15% or higher annualized return for a long period of time. Even if you consume 3-4 % of the return (via dividend or sale), your capital will still compound at 10-11%, which will take care of the corrosive effects of inflation.
If the above makes sense, then why am I not following it? Let me tell you why – The desire for higher returns! I think I can make higher returns than what I can get from these companies.
Please note the word – ‘Think’ and not would. Anyone who decides to invest on their own in all kinds of midcaps, small caps and other equity options is implicitly assuming that he or she can do better than these proven ‘blue chips’.
I am not saying that some people cannot do better, but I don’t think the lay investor who chases the current fad and hot tips, will do better than a basket of such companies. It is often smarter to make a sure 15% than chase the dream of 100% returns.