When you should not invest in the Stock Markets. Yes, there are wise people outside too.
The numbers don’t lie. Very few people invest in the stock markets — be it direct equity or indirectly via mutual funds. 95% of people prefer not to invest in the stock markets for some reason and keep their money safely in a fixed-income instrument. I guess it is safe to assume that at least 50% of this crowd is aware of the returns profile from stock markets and has intentionally decided not to invest.
Let us talk about this set of people today, i.e. the smart guys who do not want to invest in the stock markets.
This section of the population, the ultra-smart, financially literate and knowledgeable people decided to stay away from the stock market for some reason, let us find out why.
As a financial advisor, it is my job to talk to people, do the risk profiling and manage their asset allocation. The moment they say, they have no equity market investments, I spend additional time to know the reasons. The majority of them say — “My business gives me a better return than the stock markets”. The option selected was not “fear”, “lack of understanding” or “uncertainty”.
This nudged me to research this topic further and I understood there are two major aspects
- The cash flow from one’s business is not that huge that they could invest somewhere else.
- Re-investing the earnings in the same business was the most logical thing to do.
This is true for a one-shop businessman to big corporates. Either their earnings were so small that they could not invest anywhere else or their earnings were so huge that re-investing in their business made the best bang for the buck.
Nifty has returned an average of 13.3% per year CAGR for the last 20 years, which means the original capital has multiplied 12 times. The risk-free interest rate can be assumed at 7% (i.e. via Gsecs or the government of India bonds).
I hypothesize that if your business is giving you annual returns above (13.3 + 7)% = 20.3% then stay away from the equity markets. If it is equal to or lower than 20%, then you should definitely consider stock market investing — either directly or via mutual funds.
If the returns from your own business are less than 5 to 10%, then there is every probability that will get run over by a competitor. Or a change in government regulation can throw you under the bus. I know it’s hard to digest, but sooner or later you will be forced to shut the shop.
If the returns from your business are higher than 30%, able to maintain a decent operating margin and you have all the competencies, then it makes perfect sense not to diversify. In fact, you should list your firm on the stock market, raise capital, and guide people to invest in you.
Three things to remember:
- Your business is 100% active labor, you cannot stay away and expect the business to do better. Even big businesses have keyman risks. Imagine what would happen to the Adani stocks if something were to happen to Gautam Adani.
- Whereas, stock market investing is a process wherein you buy stakes in other businesses and enjoy the fruit of their labor. Other than the money involved and a bit of time taken to check the portfolio, there is no physical/mental labor involved. The returns you are getting are passive.
- 15 to 20% of your wealth should be from passive sources if you are in your 30s. At 60, at least 60 to 70% should be from passive sources. If dividends/rentals are not coming from passive sources, you are too dependent on active income and you might not really get a retirement.
Most people confuse “investing” with “making money”. I am here to tell you that both of them are different. Investing is the process of creating assets that will make you money in the future, this is passive income. And “making money” means active labor that requires you to be physically/mentally involved to generate income.
Stock markets can make you money both actively (trading) or passively (investing), so it all depends on the perspective.
These choices were made by the self-employed people who run their businesses. I am yet to see a smart, literate, and knowledgeable salaried person who decided to stay away from the stock markets.
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