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10 Useful Rules of Thumb for Your Personal Finances

I had written this post in February 2012. However, given a lot of reader emails on topics covered herein, I am re-posting it.

I use a few rules of thumb when it comes to how I manage my personal finances. Here are some rules of thumb that I practice for managing my own personal finances. I hope you will find some of these useful for your own purpose.

1. Rule of 72. The Rule of 72 states that you can divide the number 72 by whatever yield you are getting to see how long it would take for your investment to double.

For instance, if your fixed deposit earns an annual interest of 8%, it will take 9 years for your money to double (72/8).

2. The number one rule of saving money is: Pay yourself first. It’s very important to set aside your savings every month before you use the money for other things, including paying of bills. Always pay yourself before anything else.

Annual Report Review: Exide Industries

It’s annual report reading season…and a constant inflow of new reports is keeping me busy.

I have a habit of making hand-written notes on the annual reports I read (if they are soft copies, I print the important pages). This time, however, I thought of sharing these notes with you…just as an experiment. Maybe, this would nudge you closer to reading annual reports on your own, if you don’t read them.

Anyways, I start this review series with Exide Industries, India’s leading storage battery manufacturer.

Latticework of Mental Models: Deprival Super Reaction Tendency

Few weeks back when we discussed the Variable Reinforcement mental model, there was a brief mention about casino slot machines. Let me pull out that text for you –

Now that we are talking about slot machines, it’s worth mentioning another extremely intelligent aspect of slot machine design called calibrated near misses, which exploits another behavioural quirk called Deprival Super Reaction Tendency. But let me save that story for some other day.

Well, I was saving that story for today. 🙂

If you buy a ticket for the lottery that has the number 49 on it and the number 48 is drawn, you think, “I was so close…” BUT were you really? No you weren’t. If you have read the basics of statistics, you would know that the numbers in lottery are supposed to be random and the probability of each number is ideally same. So you weren’t anymore closer (or farther) from winning as you would have been if the number you got was 1.

However, that’s not how the gambling systems are designed.

In casinos, some slot machines receive better results (for the casino owner, not the gambler) than other machines based on the same payouts, same locations, same design, etc. How come?

An Extraordinary Edge You Have as a Small Investor

It goes without saying that capital allocation is a CEO’s most important job. How he allocates capital over the long run is what determines the value he creates for the business and its shareholders. But the reason many CEOs fail in profitably allocating capital is their incentives, which are aligned to what they can do in the next 1-2 years than what they must do in the next 7-10 years.

This is also how most investors and money managers work – especially after a period of good performance, they would rather go for the kill in the next few months or maybe 1-2 years, than build portfolios that would do well over a 10+ year period.

“Who wants to get rich in old age?” goes the thought process. “Why not gun for a 30-40% return and retire rich in the next 10 years?”

After all, this is what simple math suggests. If you can invest Rs 5,000 per month and do that every month for 25 straight years, and at an annual rate of return of 30%, you will have almost Rs 34 crore after 25 year.

On the other hand, if you earn just 20% annually, and everything else remains same, the amount in your bank after 25 years would be just Rs 4 crore. That’s a difference of a huge Rs 30 crore.

5 More Reasons to Read Annual Reports

Here’s an old joke. A policeman sees a drunk man searching for something under a streetlight and asks what the drunk has lost. He says he lost his keys and they both look under the streetlight together.

After a few minutes, the policeman asks if he is sure he lost them here, and the drunk replies, no, and that he lost them in the park.

The policeman asks why he is searching here, and the drunk replies, “This is where the light is.”

Behavioural scientists call this the “streetlight effect”, which is a type of observational bias where people only look for whatever they are searching by looking where it is easiest.

When it comes to investing, most people suffer from the streetlight effect and search for keys (stock ideas) where it looks the easiest (stock market and stock prices). But the reality is that the stock market is rarely the place where you can find the best ideas for long term investment.

Rather, the best ideas are found by looking at businesses, studying them, and identifying which ones are doing well, which ones may continue to do well, and which ones may be going downhill.

And how do you know that?

Latticework of Mental Models: Contrast-Misreaction Tendency

Do you remember my old friend, Mr. Irrational? He made a cameo appearance in Latticework series when we discussed Mean Reversion.

For the uninitiated, he is a figment of my imagination, inspired by Benjamin Graham’s Mr. Market.

One fine day, it so happened that Mr. Irrational was trying on suits in front of a shop’s three-sided mirror. The men’s tailor shop was owned by Sid and Harry. The younger brother, Harry, being less experienced, was sitting at the back of the room with all the design catalogues and price list.

Sid, elder brother and the chief tailor, who seemed to have hearing problems, was helping Mr. Irrational make a choice.

“How does this one look?” asked Mr. Irrational. He liked the dark grey colour but wasn’t sure about the woollen texture of the suit.

“Pardon me Sir. Can you please speak up little louder?” This was the third time that Sid had requested his patron to speak louder.

Safal Niveshak is 4 Years Old!

Baseline information suggests that 92% of startups fail before they reach age three. Safal Niveshak, which I started four years back, has crossed this barrier…and I have been extremely lucky to come so far.

So yes, it’s time to put on the big boy pants. 🙂

A lot has happened in these quick four years, but as with my four-year-old son, I’m just getting started.

Most of all, I want to thank each and every one of you for “raising” this initiative to this point — it truly could not have happened without you, dear tribe member.

I know I’ve said it before, but it bears repeating – Thank you so much for reading, for commenting, for your interest and support, for keeping me honest, for helping this entire movement of creating smarter and independent stock market investors become greater and spread wider.

You are magnificent, and I am supremely grateful for your time and attention.

Moats: Some More Thoughts

What’s interesting about moat is that if a moat needs to be continuously built, it isn’t a moat at all. How do you know if you’re paying up or overpaying for the moat? This time we invert the conundrum of moat to explore the symptoms of false-moat trap.

Over the past few months, I have spent considerable time studying about business, their longevities, moats, what helps them sustain, and what dilutes them over time.

As an investor in stocks, studying what makes a few businesses really great and their moats sustain over a long period of time, and on the other hand, what makes a majority of businesses bad and their moats, if any, fleeting has been an interesting aspect of my work.

So, while I have not yet arrived at any Eureka moment on how and why some moats sustain over a long period of time, and how can one identify in advance when a moat is shrinking, there have been some thoughts that I have formed through such reading.

I had shared some of those thoughts in my last post in the June 2015 Special Report. This post is a continuation of what else I have learned about moats, and especially about the dark side of investing in either emerging moats or ones that have already had a proven past.

I’m sure you may be wondering, “What could be the dark side of moats?”

Well, without trying to lay down any clear theories on the same, what I will be sharing below are just a few thoughts on the risks of investing in moats that you must keep in mind when you are buying such businesses that seem to be in their full glory and not destined to failure in the future.

But then, like s**t happens in real life, it often happens when it comes to investing…and that’s what makes it such an interesting game where you must keep learning…and evolving.

Let’s Start with…Destruction

When changes in the natural environment accelerate, so do the extinction rates of the Earth’s creatures. It happened to the dinosaurs and again to many species during the Ice Age. Many scientists believe we may be entering another such period.
[Read more…] about Moats: Some More Thoughts

Latticework of Mental Models: Law of Diminishing Marginal Utility

“Chocolates!” replied Soham, my nephew, with a glint in his eyes. That was his response to my question “What is happiness?”

“So you think the secret of happiness lies in chocolates?” I quizzed him further.

“Yeah! It’s bliss,” he blurted while going around in circles in his tricycle.

“Bliss?” I thought to myself, “That’s quite a mouthful of adjective coming from a five year old.”

“Okay! Here is a chocolate. Tell me if it makes you happy?”

“Thanks Mamaji (that’s what he calls me),” he screamed as he literally snatched it from my hand and in no time the chocolate was gone. He was ecstatic. May be he was right. Chocolate is bliss.

“So if one chocolate makes your happy, more chocolates should make you more happy. Isn’t it?” I was attempting to play Socratic Solitaire (the tradition of asking question that helps somebody discover the wisdom) with an unsuspecting kid.

Life 2.0: Serendipity

When was the last time you did something for the first time?

It’s an ordinary looking question but it has the power to create magic in our lives. How? Please allow me to digress a bit for a while and I’ll circle back to this line of thought little later in the post.

It’s common knowledge that every action produces an equal and opposite reaction. That’s Newton’s Law. Simply put, every cause has an effect. What’s noteworthy about this phenomenon is that some actions produce immediate effect, for example if you put your hand in fire you get burnt. Some other actions have delayed effect like you overeat unhealthy food and it makes you fat but the result isn’t immediate.

The above two cause-effect relationships are well known to everybody but there are some actions which may not seem to produce any recognizable effects, immediately or even in perceivable near future, but they end up creating significant unintended consequences.

Notice the term ‘unintended’ which means you could never have known in advance about the kind of consequences or results that will eventually be produced by your actions. Let me tell you a story.

This is a story of a guy with an uninteresting and dead end corporate job. There was no hope for him to become wealthy in his career. However in his spare time, i.e., weekends and evenings, he was always involved in some hobby projects or activities.

He learnt computer programming and developed few computer games which nobody bought. He came up with few business plans but could never convince any investors for his ideas. He attended business writing classes. He used to draw cartoons and send them for publication. He did public speaking courses. He learnt about human psychology.
[Read more…] about Life 2.0: Serendipity