Explaining equity to a first time investor
Our first task is to help investors understand the fundamentals of equity, in as simple a manner as possible. Getting the foundation right is most important for the rest of the equity journey. Here’s how we explain equity.
What are the sources of income that one normally sees? Salary, interest income, rent income and business income. Think of the businessman – he pays you your salary, he pays interest on loans taken, he pays rent on premises he uses and then he makes his business income – after paying everyone else. His income is not steady – some years he makes a lot of money, some years less. Some years he makes losses. But at the end of the day, who are the richest set of people? It is the businessmen. Not salary earners. Not landlords. Not bond owners. The world over, when you look at the richest people, it is always businessmen.
Businesses create wealth. Owning a piece of a business means owning a wealth creating asset. Equity is nothing but a piece of a business. An equity fund is a collection of such pieces of businesses, carefully selected by experts. Just as businesses have good years and bad years, your equity fund will also have good years and bad years. Just as businesses report losses in some years, your equity fund will also report losses in some years. But ultimately, just as businesses create far more wealth than salary, rent and interest, your equity fund can create a lot more wealth for you over time, than other assets that also generate returns.
Think of equity as your 3rd child
Most families have two children. We spend a lot of money over a 25 year period in educating our children, providing for all their needs, marrying them off – in short, getting them well settled in life. I tell my clients to think of equity as their 3rd child. Put in the same amount each year into an equity fund that you spend on one child. Do that for the same 25 years. After 25 years, whether your real children look after you or not, this 3rd child will look after you very well for the rest of your life. That you can be sure of!
Don’t deny your client his “kick”
Humans – especially men – crave for a “kick”. Whether it is tobacco, alcohol and a whole lot more – its all about getting a “kick”. Gambling is also about getting a “kick”. So is speculation. We all know this. But, when we discuss a financial plan with clients, we tell them with a stern face to remain disciplined in their investments for the next 20 years – just keep up your monthly instalments, month after month after month, and wait patiently for the next 10-20 years to see the outcome of your disciplined efforts. It sounds very nice in the beginning, and then, many clients get simply bored! You took away all the “fun” element from investing. Your client sees his neighbour brag about doubling his money in 3 months on a hot small cap stock. He comes to you and talks about it, and you sternly tell him to avoid all this mindless speculation and stay on course – month after month after month. He wants that “kick”, you deny it to him. He is not a small child who simply has to listen to you.
We need to be more mature about this. We create a core and satellite portfolio for exactly such circumstances. First, we need to understand that not creating a satellite can endanger the core, when a client expresses a desire for more “action” in the portfolio. Once a satellite is created of a mutually agreed portion, and the core is left to grow one SIP at a time, we get talking about “action” in the satellite portfolio. We discuss technical analysis, we discuss market trends, we discuss stock ideas. We try to help the client invest the satellite intelligently, rather than recklessly.
Please talk markets with us
We never dissuade clients from talking markets with us. I know some planners actively dissuade market conversations out of fear that clients will then get into short term thinking, which can endanger their long term plans. We think differently. We actively encourage clients to talk to us about markets, trends, global factors, local factors – the works. Clients who want to understand markets more, should be actively encouraged. They want more involvement, they want more engagement – give it to them. Ensure that you have a core and satellite portfolio structure agreed with them, then go right ahead and help them get as deeply involved as they want to. Allow clients to get an equity experience the way they want, rather than prescribing only one way and discouraging all other conversations.
Think of yourself going to a restaurant. The restaurant serves you good food. You go to another. This restaurant also serves good food. But the chef comes out, talks to you about the food, for those who are interested, he willingly shares his recipes. Which restaurant will you want to go back to now?
The key is to engage and involve your clients. The more you involve them, the better is the overall experience you give your clients.