Saving Early. The Magic of Compounding.

Recently, I came across an article on saving early that claimed something which seems extraordinary on the face of it. It claimed that if you started saving for your child’s(!!) retirement at the time the child is born, then something extraordinary happens.

If you save 5000 Rs. a month, the article claimed, and you put the money into equities( where return was supposed to be 18% per annum, as per the article), and if you kept increasing this sum by 5% per annum (so that in year 1, you were saving 5250 per month, and in year 2, a little more than 5500 per month), and you kept saving for the first 20 years of your child’s life, and then stopped, keeping the corpus intact, then, the article claimed that at the time of your child’s retirement (Age 65), your child would have 1000 crores of Rupees.

Extraordinary, isn’t it? The magic of compounding plays out so wonderfully, when you start compounding over 65 years. I tried to do the calculation myself, and I in fact, assumed that the entire money (60000 Rs.) would be invested in the beginning of the year itself. And that led to the even more astonishing figure of Rs. 2700 crores.

Of course, this isn’t particularly realistic. The first assumption is that you would get 18% return on equities. Frankly, this isn’t a very tenable number, and very few individuals would have obtained 18% a year over 65 years (Warren Buffett is one of them, but then, he is both an owner and an investor, and he has float from insurance companies). A more realistic assumption would be something like 13-14%.

However, even if you assume a smaller return of 13%, the figure still comes to a respectable 212 crores. If you assume an inflation rate of 5%, then that comes to nearly 10 crores in today’s money, surely a comfortable sum to retire on for most people. Maybe 9 crores after taxes.

It also goes to show, the importance of saving early. It is the 65 years of compounding which causes these crazy sounding figures to come up.

Most people, of course, struggle to save for their own retirement, let alone their children. So let us look at how saving early can help such folks.

Suppose a person starts working at Age 22, and works till the retirement age of 65. Suppose they save 60000 per annum at the end of every year (or 5000 a month). And they invest it only in PPF account, which gives them 8.5% tax-free (Not counting the impact of the tax benefit of such an investment at the time of investment).

In that scenario, they would have a corpus of 2.45 crores at the age of 65.

Suppose, you start saving at the age of 30, i.e., 8 years later. In 8 years, you would have saved only Rs. 4.8 lakhs less than the individual who starts saving at the age of 22. But in this case, at age 65, you would have only Rs. 1.26 crores at the age of 65. A huge Rs. 1.2 crores less.

Maybe we take a more realistic scenario, where the amount you can save increases with time. Suppose you start saving Rs. 5000 a month at age 22, and increase this by 1/3rd every five years, then at age 65, your corpus will become Rs.4.9 crores. And if you do the same thing, starting at age 30, you would have only Rs. 2.2 crores. The difference gets even more magnified.

And this is assuming only a 8.5% return. Recently, I checked my NPS returns (I have been saving in NPS since 2010, in a 50:30:20 portfolio (50% equity, 30% Government Securities, 20% corporate bonds), which is relatively conservative. In this scenario, my return has been a little under 10.5% over these 9 years.

If we would plug in these figures, the small tweak in the return, leads to a scenario where instead of Rs. 4.9 crores in the scenario earlier, then corpus would become Rs. 8 crores (Saving Rs. 60000 every year from age 22, increasing by 1/3 every 5 years). As opposed to this, starting at age 30, the corpus would have become only Rs. 3 crores, as opposed to Rs. 2.2 crores. The higher return has dramatically magnified the advantage of saving early.

This last comparison is illustrated in the graph below.

The Importance of Saving Early is well demonstrated in this graph
Shows the cumulative corpus if Rs. 60000 is saved every year, with the sum increasing by 1/3rd every 5 years, and a return of 10.5% per annum..

The first lesson in personal finance is therefore, to start saving early. The second is to try and maximise the return. In another post, I will try and explain why, if your horizon is long, it is sensible to be a little more aggressive and bump up your returns.

Trading Returns February 2019

The below table summarized my trading returns, along with my investment returns over the last 27 months. As you can see, trading has given me exceptional returns over the last 27 months, but poor returns over the last year.

Trading Returns over the last 27 months, since inception.
Trading Returns compared with Investment Returns as well as a number of other benchmarks.

The months of January and February have been particularly bad for my trading returns. The BankNifty (which constitutes almost 80% of my trading portfolio) yo-yoed in a strict range for 2 months. In addition, I think we biased ourselves in favor of extremely fast strategies. This had a tendency to really ruin returns in such a market environment.

The important thing to note is that we still have positive returns for banknifty trading till February in the financial year 2018-19. The loss has come almost entirely from commodity futures, interest rate futures and options trading. For six months, though, we quite outshone every other benchmark by trading. This was because of a wonderful run in August and September.

This is all what trend following trading is all about. Sharp bouts of phenomenal performance, followed by a long period of drawdown. The challenge for any portfolio constructor is to minimize the extent and frequency of drawdown. We are still in a learning phase as far as that is concerned.

Investment Returns February 2019

I have not disclosed my investment returns since a few months. This is because I started a new portfolio of trading stocks, which have a lot of churn. So I just had to understand how to keep the two portfolios separate in my database. It took me a couple of months to get around to the point of making appropriate changes in my database, and in doing the programming changes necessary.

Here is a graph of in investment returns, also as compared to a number of benchmarks.

Investment returns for the period from November 2016 to February 2019, as compared to various benchmarks, including a PMS, TRI Indexes, and top mutual funds.

As you can see, the top performance over the last 2 years or so is no longer the SBI Smallcap fund. Riding on the basis of largecap outperformance throughout 2019 the NIFTY TRI remains the best performer of all benchmarks, followed closely by the HDFC Top 100 Fund.

Again both mutual funds, the HDFC Top 100 and the SBI Smallcap Fund, outperformed both my portfolio as well as the PMS.

Clearly performance is dictated by the kinds of stocks which constitute the portfolio, given the exceptionally large divergence in the returns of a large cap, midcap and small cap portfolio over the last year.

As I write this post, there has again been smallcap and midcap outperformance in the last month. We will see the results next month.

Portfolio Disclosure March 19,2019

Here is a list of the stocks in my portfolio which constitute more than 1% of my investment portfolio. Interested readers may compare it with an earlier portfolio disclosure. I also provide the unrealized gains in terms of percentage.

Ticker% of Portfolio% Unrealized Gains

Benchmarks against which to measure performance

In the table, I give three figures which reflect my own performance along with other benchmarks:

Every month, I have been giving out a summary of my trading and investment performance. Here I give my own performance, along with other benchmarks. The question is, what are these benchmarks? Are they appropriate? How should one look at these benchmarks. Here I will just elaborate on these benchmarks.

a) My investment returns: This is for that capital which is deployed on a long term basis, without any leverage. The typical churn in this part of my portfolio is less than 10% a year. My investment returns as given include dividends received on stocks.

b) My trading returns: Trading returns are those returns which are given for the various trading strategies I employ. These returns in percentage terms are only on the actual capital employed (cash+cash equivalents like liquid bees). The percentage returns do not reflect the fact that approx 40% of the capital is in stocks of companies which are pledged as security. These returns must be evaluated accordingly. My trading returns also include my returns on commodity futures and interest rate futures, as well as the occasional option trade. Most such trades are always in the market (i.e., they are not long-flat, they are long-short). When the trend reverses, typically, my trade will move from long to short or vice versa.

c) My returns on traded equity: This is more recent. Since October 2018, I have deployed a significant amount of capital (Approx 15% of the total capital in my investment portfolio) into equity shares on a non-leveraged basis. The basis for selecting these stocks is purely by trend following techniques. These stocks are not meant to be invested for the long term. As soon as the trend reverses, there will be a sell. This is a long-flat strategy. No shorting is done.

Coming to the various benchmarks:

a) I have indicated the Nifty Total Return Index(TRI), Midcap-150 (TRI) and Smallcap-250 (TRI) as the appropriate benchmarks for my portfolio. My current investment portfolio consists of 20% large caps, 50% midcaps and 30% small caps. So my actual returns should be someway better than the returns of these three strategies combined in the above proportion.

b) Among other benchmarks, I have also included 2 mutual funds, both of which are famous outperformers in their respective categories. They are not the category average. These two benchmarks include the HDFC Top 100 fund (Used to be the HDFC Top 200 fund earlier), and the SBI Small Cap Fund (Used to be the SBI Magnum Small and Midcap Fund earlier).

c) I have also indicated the returns from the Centrum-920 Deep Value PMS (in which I have invested a small amount), so that my investment returns can be benchmarked with it.

d) Finally, I have indicated returns provided on a small amount of trading capital to an individual named Chandan Kumar, who trades it on my behalf, using options strategies that he has developed. My trading returns could be compared with his returns, since he uses similar amounts of leverage.

Trading Strategies currently Deployed

Currently, I am employing the following trading strategies in financial markets:

b) Trend Following on the BankNifty Futures on EOD time frame, with a mix of fast responding and slow responding strategies (Approx 30% of total capital)

a) Trend Following on the BankNifty Futures on 5 min, 15 min and 30 min timeframes (Approx 10% of total capital)

c) Mean reversion trades on Stock Futures (Approx 5% of total capital)

d) Trend Following on Interest Rate Futures (Approx 10% of total capital)

e) Momentum and Trend Following on Commodity (Silver, Gold, Zinc, Crudeoil and Copper) Futures (Approx 10% of total Capital).

f) Trend following on NSE500 stocks (non-leveraged) (Approx 35% of total capital)

Capital is employed by means of 50% stocks (with about 25% haircut), 40% liquid bees(10% haircut) and 10% cash. Non leveraged trades on NSE 500 stocks needs cash too.

To protect against black swan events, I generally buy protective puts in BankNifty weekly options in the situation where more than 50% of the maximum position is long.