John Kay

The RISK of RISK of Investing in Stocks, which OPIUM Managers Don’t Talk About

Summary: Just because you have taken on a risk by investing in stocks, doesn’t mean high returns are going to materialise.


The only function of economic forecasting is to make astrology look respectable – John Kenneth Galbraith.

It was sometime in October-November 2010. I had just joined a weekly personal finance newspaper, which for reasons I did not understand and for reasons above my paygrade, was to be run out of Delhi.

During the course of one editorial meeting, we had to decide what sort of return would systematic investment plans (SIPs) into equity mutual funds generate over the next decade. This was necessary as a part of a regular feature to be published in the newspaper, which would help a featured family come up with an investment-savings plan.

It was assumed that SIPs into equity mutual funds would generate 15% per year return. I protested against the assumption saying that 15% per year return was way too high but was overruled by the Delhi bosses.

At that point of time it had almost become fashionable to say that the stock market generates 15% return per year in the long term (In fact, there are people who still believe in this myth, which I shall write about in detail in the time to come).

Getting back to the point. We are now in 2020. 10 years have gone by. As I pointed out in a piece yesterday, the SIP returns on index funds have been rather subdued over the last decade. The average per year return over the last decade in case of the three Nifty index funds I checked was slightly over 9% (around 9.17% to be very precise). Index funds are funds which have a mandate to invest money in stocks that make up a stock market index, in the same proportion that they do.

The per year return of a little over 9% was nowhere near the assumed 15% per year return. Let’s say an individual had invested Rs 10,000 per month religiously through the SIP route for ten years. On this if he had earned a return of 15% per year, the value of his portfolio at the end of 10 years would be Rs 27.5 lakh.

If the return was 9.2% instead as it actually turned out to be, the value would be around Rs 19.6 lakh or around 29% lower. If the individual was saving towards a certain goal, he would end up way short. But that’s the rather obvious point here.

The question is how did the market narrative of stocks giving 15% return in the long-term come about? The first time I heard this 15% argument being made with a lot of confidence by marketmen was sometime in late 2006 or perhaps early 2007.

This, after the Indian economy had grown by greater than 9% in real terms for three consecutive years, 2004 to 2006. The zeitgeist or the spirit of the times that prevailed was that come what may India will now grow by at least 8% in real terms. Add an inflation of 5-6% on top of that and we will grow at 13-14% in nominal terms, year on year.

Assuming that the earnings of companies which are a part of India’s premier stock market indices would grow a tad faster than the nominal growth, we arrived at 15-16% year on year growth in earnings.

This would be reflected in stock prices growing by 15-16% per year as well. From here came the assumption, the stock market growing at 15% in the long-term. There is a lot more to this assumption including Sensex returns from 1979 on, but I will leave that for another day. For the time being knowing this much is fine.

In fact, over the years, I have seen this logic being offered by people who make their money in the stock market by managing other people’s money or OPM or even better OPIUM, with great conviction. These tend to include fund managers, analysts, traders, salespeople etc. (Oh, if you still didn’t get it, OPM and OPIUM sound the same. Rather childish, but good fun nonetheless). Those in the business of managing OPIUM really believe that stocks give 15% per year return over the long-term (I even wrote a piece on this titled Why Economic Growth Cannot Be Created on an Excel Sheet. You can read it here).

The trouble is that this assumption has turned out to be all wrong. The earnings growth has been nowhere near what the OPIUM managers have been projecting. This is reflected in the 10-year return on stocks, which as of August 20, 2020, stood at 8.7% per year (based on the Nifty 50 Total Return Index, which takes dividends paid by companies into account as well, unlike the normal index).

The funny thing is that the stock market has delivered a return of just 8.7% per year over the last decade, despite the valuations being at all time high levels. The price to earnings ratio of stocks that comprise the Nifty 50 index is around 32 these days. This basically means that for every rupee of earnings for these stocks, the investors are ready to pay thirty-two rupees as price. As I pointed out yesterday, such high valuation has never been seen before.

And despite such a high valuation the decadal per year return on stocks on an average is less than 9% per year. This is the irony of it all. It also makes me wonder why investors think that the stock market is doing well. Yes, it has done well in comparison to where it was in late March 2020, but clearly not otherwise.

Of course, when the OPIUM managers talk about 15-16% return per year from stocks over the long-term, they also highlight the fact that for higher return a higher risk needs to be taken on by the investor. The higher risk is the risk of investing in stocks for the long-term.

But what they don’t talk about is the fact that just because you are taking the risk of investing in stocks for the long-term, doesn’t mean that higher returns are going to materialise. I would like to call this, the risk of risk of investing in stocks, something which most OPIUM managers don’t seem to talk about.

The question is why does this happen? The answer lies in the fact that OPIUM managers are in the business of driving up assets under management for the firms that they work for. More the money that gets invested in a fund, the higher the fee earned by the firm to manage that money. And in this business of soliciting money, you need to sound confident.

The moment you start getting into nuance about high risk not guaranteeing high returns, you start losing the average prospective investor. Hence, the projection of confidence that the prospective investor is looking out for, leads to simplistic one-line market narratives like stocks will definitely give a 15% per year return, over a decade. Such narratives are easier to sell.

In a world full of complex uncertainties, the prospective investors are looking for certainty and those in the business of managing OPIUM can’t consistently project confidence to tackle the complex uncertainties, unless they believe in stocks giving 15% per year return in the long-term, themselves. This is the con of confidence which fools people on both sides.

The trouble is such narratives hurt. As  economists John Kay and Mervyn King write in Radical Uncertainty – Decision Making For an Unknowable Future: “Markets narratives are occasionally ‘dishonest and manipulative’, but normal people make honest use of narratives to understand their environment and guide decisions under radical uncertainty.” (King and Kay’s book is a terrific read though not a breezy one. Highly recommended).

This is not to say that one should not invest in stocks and invest all our money in bank fixed deposits. Not at all.

All I am trying to say is that just because you have taken on the risk of investing in stocks, doesn’t mean higher returns are going to materialise and which is why it’s called risk in the first place. So, you might end up short on the corpus you were trying to build (assuming you are trying to do this in a systematic way).This is something that needs to be kept in mind while investing in stocks either directly or indirectly through mutual funds. This is the risk of risk of investing in stocks. While all mutual fund ads have a disclaimer at the end saying that mutual fund investments are subject to market risk, nobody really explains to the investor what exactly this market risk is.

The economist Allison Schrager makes this point in the context of saving for retirement in her brilliant book An Economist Walks into a Brothel—And Other Unexpected Places to Understand Risk. The conventional wisdom is that when it comes to saving for retirement it makes immense sense to build up as large a retirement corpus as possible and then spend it at the rate of, say 4%, per year, after retirement.

The problem with this strategy is that 4% per year isn’t really a fixed amount. It depends on the retirement corpus one has been able to build up in the first place. And that in turn depends on how the stock market has been doing. As Schrager writes: “That’s where the strategy goes wrong.”

One way of getting around this problem is that in the years approaching retirement you take your money out of stocks and invest it in fixed income investments, everything from bonds to fixed deposits. This mitigates the risk to some extent but not totally.

What if the stock market is not doing well in the years before retirement? What do you do then? Do you continue staying invested in the stock market in the hope that it recovers, and you build a better corpus? What if it doesn’t?

That’s the risk of it all. At the cost of repeating just because you have invested in stocks and taken on a higher risk doesn’t mean higher returns are automatically going to materialise.

To conclude, it is important that as a stock market investor you realise this, irrespective of whether the OPIUM managers communicate this or not.

Stay safe and enjoy the weekend.

Will see you now on Monday (or perhaps Tuesday, depending on what my brain throws up over the weekend).

Disclaimer: This article is meant for educational purposes only.  

Why we buy life insurance

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Why do people buy life insurance? In a logical world, the answer would have been very straightforward.

People buy life insurance because they want to hedge against the probability of death. But is that really the case? The answer is no. Most life insurance that gets sold in this country is not really life insurance in the strictest sense of the term.

What gets sold as life insurance is essentially an investment plan with a dash of insurance. Hence, in most cases people who buy life insurance aren’t really adequately covered. So this brings us back to the question, why do people buy life insurance?

There are multiple answer to this question. I call a certain section of individuals buying life insurance as the “Papa Kehte Hain Types” or the PKHTs. The PKHTs buy insurance because their fathers ask them to do.

The only way their fathers have known to save is by buying life insurance policy regularly from the friendly neighbourhood agent.

Further, a major section of people graduate from being PKHTs. They dabble around on their own and figure out that if you buy insurance policies
save tax. This leads to people accumulating multiple insurance policies, without having much idea of what they are buying. Over the years, I have even known people who have had a dozen insurance policies and struggling to remember, when is the premium due on which policy.

Some others buy insurance because they need to oblige their friends, their relatives, their acquaintances, who have become insurance agents, for the lack of anything better to do. In fact, some portion of the PKHTs also fall into this category of buyers.

Still others are mis-sold insurance when they go into a bank to start a new fixed deposit or carry out some other transaction. In fact, given that I work as a freelance writer, my payments tend to be lumpy. The last time I went to my bank, a major payment had come through, and not surprisingly, the woman at the front desk, tried to sell me life insurance which, she said, would give me fantastic returns.

The moment I asked her, how can life insurance give returns, she got confused, and asked me to speak to her senior.

The point being that nobody really buys life insurance to hedge against the risk of dying. Further, given that most insurance policies are essentially investment plans, nobody really buys them as investment plans either.

The insurance companies are also happy letting people buy insurance for various reasons other than the probability of hedging against their death. Very rarely do insurance company advertisements talk about death. They do talk about investment but in a very vague sort of way, without really getting into the past performance of their investment plans.

As John Kay writes in Everlasting Light Bulbs—How Economics Illuminates the World: “Modern economies include many activities, like selling cars, where product quality and product attributes are complex and sellers know far more about what they sell than buyers about what they buy.” Insurance is one such product.

In case of insurance, the companies rarely go about filling the information gap and educating the buyer, through their advertising. When was the last time you saw an insurance company talk about the fantastic returns that its investment plans have generated? When was the last time you saw an insurance company talk about their premiums being the lowest?

In fact, as Kay writes: “Advertising is about managing that gap in information. And when you look more closely at advertising with that perspective, you see that the distinction between information and persuasion does not really stand up.”

Hence, the next time an agent tries to sell you life insurance, just ask them what has been the performance of their investment plan, over a period of five years, in comparison to other plans offered by other insurance companies.

Rest assured, the agent will not have an answer for this.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror on April 27, 2016

Ruminations on the Bihar election

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I normally stay away from writing on politics given that I don’t track it closely enough. Nevertheless, having been born and brought up in erstwhile Bihar, the politics of Bihar has always interested me. And given this, I was closely tracking the state assembly election results when they were declared earlier this month.

As the election trends started to come in, the Bhartiya Janata Party (BJP) led National Democratic Alliance seemed ahead. The experts and analysts on news channels immediately started offering reasons for the same. They said that the Grand Alliance leader and the chief minister of Bihar, Nitish Kumar, had turned arrogant during his second term. He had lost the connect with the youth of Bihar, who were now batting for Narendra Modi. The caste factor had finally been destroyed in Bihar (something remarkably stupid to say on live TV) and so on.

I did not hear any of these experts say, let’s wait for more trends as well as results to come in. Things started to change after sometime and the Nitish Kumar led Grand Alliance raced ahead and eventually won the elections convincingly, winning 178 out of the 243 seats in the state assembly.

As the Grand Alliance surged ahead the narrative of the experts and analysts on TV also changed. They now offered reasons on why Nitish Kumar was such a star. Apparently, there was no anti-incumbency at work. The women had come out in full support of Kumar. Further, Lalu Prasad Yadav’s supporters (the Muslims and the Yadavs) had voted whole-heartedly for the Grand Alliance, even though they knew that Lalu would not become the chief minister.

At the same time, it was said that Modi and Amit Shah’s brand of divisive politics had not worked. The RSS chief Mohan Bhagwat’s comment of taking a relook at reservation also did not go down well with the voters of Bihar.

The entire analysis offered on TV during the counting of votes and after the declaration of results was an excellent example of what economists call the teleological fallacy. As John Kay writes in Obliquity—Why Our Best Results Are Achieved Indirectly: “The teleological fallacy, which infers causes from outcomes, is one of the oldest mistakes people make…In the business and political spheres the assumption that good or bad outcome derives from good or bad design remains pervasive.”

Why does this happen? As Kay puts it: “The human mind is programmed to look for patters and to seek causes.”

So what did really happen in Bihar? In the 2014 Lok Sabha elections, the NDA had got 38.8% of the votes. In the 2015 state assembly elections this fell to 34.1%. In the 2014 Lok Sabha elections the alliance comprising of Lalu Prasad Yadav’s Rashtriya Janata Dal, the Congress Party and the Nationalist Congress Party, had polled in 30.2% of the votes.

Nitish Kumar’s Janata Dal(United) had polled in 16.04% of the votes. But Kumar was not in alliance with Lalu and the Congress. Hence, their vote was split and the NDA won the majority of the seats in the state during the Lok Sabha elections.

If there had been an alliance between Nitish, Lalu and the Congress, they would have polled in a little over 46% of the votes, which would have been more than the 38.8% that the NDA polled.

This time around Lalu, Nitish and Congress got together and they got 41.9% of the votes. The NDA on the other hand won only 34.1% of the votes. The point is that the anti-Modi vote was always in the majority, only this time around the votes were not spilt.

This was the real reason why Modi led NDA lost Bihar so badly. Now whether the voter voted against Modi because of cow politics, Shah’s Pakistan comment or Bhagwat’s reservation comment, that only he knows. And the vice versa is also true i.e. whether the voter voted for Kumar because of his development policies or caste affiliation, that only he knows.

The analysts and the experts can only speculate.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected] )

The column originally appeared on Bangalore Mirror on November 25, 2015

Why Facebook hasn’t killed email

facebook-logoWe live in an era where we have multiple ways of communicating with each other. The landline phone is still used. Then there is the mobile phone. We also have Facebook, Twitter, Skype, WhatsApp, Telegram, imo, and a whole host of other web based messaging applications.
And we still have the email.

The funny thing is that email has managed to survive the onslaught of so many web-based applications. While people may no longer be sending email forwards like they used to, or writing very long emails, a lot of communication (especially the formal kind) still happens over email.

Why is that? Before I get into answering this, it is important to understand a term called “network externality”. As economist John Kay writes in his book Everlasting Last Bulbs—How Economics Illuminates the World: “Network externalities are a new buzzword in business economics…in which the company that is first to create the largest network denies access to competitors and establishes an unassailable monopoly…Connectedness is vital, and it is best to be connected to the largest network.”

Take the case of Facebook. It is one of the best examples of network externality. As economist Paul Oyer writes in his book Everything I Ever Needed to Know about Economics I Learned from Online Dating: “The rise of the internet has made network externalities more apparent and more important in many ways…

Perhaps the best example of the idea is Facebook. Essentially, the only reason anyone uses Facebook is because other people use Facebook. Each person who signs up for Facebook makes Facebook a little more valuable for everybody else. That is the entire secret of Facebook’s success—it has a lot of subscribers.”

This explains why Google+ despite getting fantastic initial feedback from the tech freaks, never really took off—everyone was already on Facebook. This also explains why Orkut had to shut down because everyone had moved to Facebook.

As Niraj Dawar writes in Tilt – Shifting Your Strategy from Products to Customers “For those who want to be a part of a social network, it makes sense to congregate where everybody else is hanging out. There is only one village square on the internet, and it is run by Facebook. Being on a different square from everyone else doesn’t get you anywhere—you just miss the party.”

Further, what this also tells us is that in order to communicate with someone who is on Facebook, you need to be on Facebook as well. But that’s not how things work everywhere. Take the case of the mobile phone. Calls made from a phone connection issued by one company are not limited to only those connections issued by the same company.

As Kay writes: “The world telephone system consists of many operators, large and small. Most provide service in a particular geographical area, and connect each other call’s through negotiated access agreements.”

The same stands true for ATMs as well. Payments can be made across banks. “Today, a network of clearing and correspondent agreements ensures that you can make a payment through your local bank to anyone in the world,” writes Kay.

But this is something that is not possible in case of the web based messaging services. You cannot send a message from Facebook to WhatsApp, for example. As writer Kevin Maney puts it: “Email is technology’s cockroach: Everyone hates it but we also can’t kill it. We can’t kill it because it’s the only communications tool since the telephone that is universal. As company walls and national borders break down in cyberspace, email is the only way we can share ideas and digital matter with nearly anyone, anywhere.”

And why is that? As Maney explains: “Different age groups and different nationalities are latching onto messaging apps, but the messaging apps don’t talk to one another, or even do the same things.”

This explains why the email has managed to survive the onslaught of the web based messaging applications and continues to be used.

The column originally appeared in the Bangalore Mirror on November 4, 2015

One-rank one-pension – An economic analysis of an emotional issue

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I have been quoting a lot from the writings of British economist John Kay in my recent columns. The reason for that is very straightforward. I have read two very good books (Other People’s Money – Masters of the Universe or Servants of the People and Everlasting Light Bulbs – How Economics Illuminates the World) written by him over the last two weeks. A lot of what Kay writes is very relevant for the times that we live in. And given that I have ended up quoting him over and over again. Today will be no different as well.

In an essay called A Fetish for Manufacturing which is a part of Everlasting Light Bulbs, Kay talks about an article he wrote in 1980. In this article he predicted that the British manufacturing would decline due the growth of North Sea oil production. Kay doesn’t explain the reason behind his prediction in the essay I am talking about and honestly, it is not important, given the point I am trying to make.

After the article was published there was a lot of controversy around it. As Kay writes: “Few critics focussed on the weakness in the argument. They claimed instead that what I was saying ought not to be true or, if it was true, ought not to be said.”

After a point, Kay started to understand “that for many people the role of manufacturing industry was an emotional issue rather than an economic one.” The phrase I want you pay attention on is that, “it was an emotional issue rather than an economic one”.

Something similar is playing out in India right now – the issue of one-rank one-pension for India’s armed forces. When an individual retires from the armed forces, he gets a pension. The pension amount depends on the date of retirement. Up until very recently, there was no ‘one-rank one-pension’ in the armed forces. This essentially meant that individuals who retired at the same rank and had served similar number of years, did not receive the same pension, if they retired at different points of time.

Given this, an individual retiring in 2004 would get a lower pension than the one retiring in 2006, despite having retired at the same level and having served for a similar number of years.

It also needs to be mentioned here that a bunch of armed force personnel retire in their mid to late 30s and unlike the general segment of the population do not get benefits of a full-pay until the retirement age of 58 to 60.

The armed force veterans have been demanding one-rank one-pension for a while now. It was one of the key promises that Narendra Modi made during the campaign for the last year’s Lok Sabha elections.

On September 5, 2015, the ministry of defence announced one-rank pension for the armed forces. As the press release said: “In simple terms, one-rank one-pension implies that uniform pension be paid to the Armed Forces personnel retiring in the same rank with the same length of service, regardless of their date of retirement. Future enhancements in the rates of pension would be automatically passed on to the past pensioners. This implies bridging the gap between the rate of pension of current and past pensioners at periodic intervals.”

And given that it took close to sixteen months for the Modi government to come up with anything concrete on the issue, it is not surprising that the issue has turned into an emotional one. Individuals who defend the borders of India, need to be treated better, is an oft-repeated argument.

The government estimates that “to implement OROP, the estimated cost to the exchequer would be Rs. 8,000 to 10,000 crore at present, and will increase further in future.”

The question is can the government afford this? Let me make a slight deviation before getting back to the question.

I have been reading through this interesting book called The Challenge of Things—Thinking Through Troubled Times, written by the British philosopher AC Grayling. In one of the essays in the book titled Does the Government Know Best, Grayling writes: “Much of the debate about levels of welfare spending concern how much security should be provided, not whether or not it should be provided. The consensus in question is that the state has welfare responsibilities; the arguments are almost always about how much should be spent in discharging them.”

So this brings us back to the question whether the government can afford this? And if yes, how much should it spend on it? The total budgeted expenditure of the government for the current financial year stands at Rs 17,774,77 crore. Rs 8000-10,000 crore is around 0.45-0.56% of that expenditure. Hence, if looked at in isolation, one-rank one-pension is clearly affordable for the government.

Nevertheless, the thing is that it won’t stop at just armed forces. As a report in The Asian Age points out, the Central paramilitary forces also want one-rank one-pension. This includes the Border Security Force, the Central Reserve Police Force, the Central Industrial Security Force, the Indo-Tibetan Border Police and Sashastra Seema Bal.

These forces are responsible for our borders as well as security within the country. They tackle the naxal threat as well in large parts of the country. So how can they be left out of one-rank one-pension? I think that is a fair question.

The Asian Age reports that the Central paramilitary forces have a strength of nearly nine lakh serving personnel and six lakh retired personnel. I haven’t come across any clear thinking by the government on this issue.

It doesn’t stop here. The PTI reports that the railwaymen also want one-rank one-pension. As the newsreport points out: “Railway employees are now asking for similar pension benefit, arguing that their duties too are “hazardous, risky and complex”. In a letter to Prime Minister Narendra Modi, National Federation of Indian Railwaymen has demanded uniform pension policy for railway employees. “On an average, 800 railway employees get killed per year in the course of duty and nearly 3,000 sustain injuries at work,” M Raghavaiah, general secretary of NFIR, said.”

Saurabh Mukherjea and Sumit Shekhar of Ambit point out in a research note that the “cost of salaries/pensions for railway employees is 2.7 times the cost of salaries/pensions of the armed forces”. Railways currently employs nearly has 13 lakh individuals.

Once all these factors are taken into account one-rank one-pension suddenly starts to look like an expensive proposition.

The question is will the government be able to stop after the armed forces? I don’t think so. And how will they finance this?

As John Kay (Oops I am quoting him again) writes in an essay titled How We Decide which is a part of Everlasting Light Bubbles: “Big decisions in politics and businesses are the result of political horse-trading, and are based on partial information, visions and prejudices, hopes and fears.”

The feeling I get is that people in decision making positions haven’t thought through the issue at the level they should have. In the years to come other government agencies will also demand one-rank one-pension and they are more than likely to get it.

Rest assured, you will hear more about one-rank one-pension in the years to come.

Watch this space.

The column originally appeared on The Daily Reckoning on Oct 16, 2015