‘Mad Money Journey’ is a finance fiction – a rare combination of finance and fiction written by a dear friend, Mr. Mehrab Irani. Mehrab has beautifully articulated principles of life and money in this wonderful book along with a glimpse of the culture of many countries. Reading this book is a must for everyone who wants to accomplish financial freedom.
Here are my biggest learnings from the book:
What is money?
Money, simply stated, is a means of exchange and in that sense, it is a commodity. During the barter system, people used to exchange goods. Over time, one leg of that barter system emerged as a universally accepted good called ‘money’.
Is money scarce?
No. The only thing available in abundance in this world is money. Central Banks can print as much money as they want. Entrepreneurs too can print money – they print shares and sell them for cash. The author states “The problem is not money, but the lack of knowledge about it.” We should understand the basic nature of money and then think on the ways to attract money, and migrate from working for money to making money work for us, if we want to generate guaranteed, passive and portfolio income.
What are basic contours of money?
Earning, Saving, Spending, Investing, Leveraging, and Insuring are basic contours of money. One needs to understand each of these aspects in detail to accomplish ‘Financial Nirvana’.
What do you mean by earning?
There are two types of earning – active earning and passive earning. Active earning is the earning from your active efforts such as income from a salary or a profession (Doctor, lawyer, architect, engineer etc.) by rendering service.
Passive income is the income earned from your assets. Interest on fixed income securities, dividend from equity, rental income from real estate, royalty income from patents, books, videos etc., and income from sale of assets (called portfolio or asset income) are examples of passive income.
Remember, all earned dollars are not same. All these streams of incomes are taxed differently and what you should focus on is ‘Post-tax income’. Unfortunately, active income is the hardest to earn and is subject to the highest taxes. Tax rates are favourable to passive income streams.
Who takes what portion of your income pie?
Income tax takes the first share of your income. It is interesting that all individual earners spend money from the post-tax income; However, cooperates spend money from the pre-tax income which means they first spend and then pay taxes on whatever is excess over their expenses (called profit before tax).
Equated Monthly Instalments (EMIs) on your loans (home loan, car loan and other personal loans) take away another portion of your income. Operational Expenses including utilities claim the third portion of your income. Inflation, Indirect taxes, and various intermediaries make continuous claims on your income.
Increase your financial and legal literacy by studying accountancy, taxation and securities laws so as to make the right choice for the medium of earning, investing, holding the assets and succession planning. Remember what Mr. Buffett said, “To earn more, you have to learn more.”
What do you mean by paying yourself first?
Paying yourself first means to ‘Save before you spend, or spend what is left after saving’. Treat saving as mandatory as paying taxes and EMIs. Never spend more than you earn; always have income more than expenses that result into positive operating cash flows. Never buy things that you don’t need, otherwise you will be forced to sell the things that you need. Don’t consume all your earnings today. Save some portion for tomorrow. In other words, savings is the first step to building wealth and it is important to adopt ‘delayed gratification’ as life approach.
Does the saving build wealth?
No. Instead, your money lying in your bank account earns interest less than inflation and that too is a taxable income. In other words, inflation is continuously eating into your savings and making you poorer each day by reducing the purchasing power of your money.
The next step in building wealth is ‘investing’ across the four asset classes – Equity, Variants of fixed income securities, Real estate, and Gold. Gold is an efficient hedge against the inflation, Real estate is to have shelter on your head, Fixed Income Securities provide you regular passive income, and Equity builds wealth. One needs to understand three enemies of every asset class – inflation, taxation, and the cost of maintaining assets. Further, your focus has to be on net return (net of expenses and taxes) from your investments. In a nutshell, don’t confuse ‘saving’ with ‘investing’.
What is investing?
Investing is a specialized profession and not a ‘Do it yourself – DIY’ activity. It demands skill, discipline and is a serious business. If you have to start a business, you choose that with significant long term perspective, similarly, you should choose your investments after lots of rejections. Therefore, investing is an elimination strategy and demands business-like approach to produce the best results.
Investing is all about asset allocation with long term perspective. It’s a dull, boring, no excitement exercise and demands commitment, understanding and patience. A cool, calm meditative and thinking mind is pre-requisite for successful investing. It’s not gambling, entertainment or hobby. It is not a ‘Get Rich Quickly’ fix at all.
Best investments happen at the worst of the times – be it equity, real estate or anything. Equity is best investment during the crisis and when there is blood on the street. Similarly, best bargain on the properties is available at the foreclosures. Remember that money is made in investments at the time of purchase and realized at the time of sales. Therefore, if your entry point for any investment is reasonably right, you will eventually make money.
If you don’t have competence, time, energy and/or required mindset, it is advisable to find a competent and trustworthy investment advisor. Fee to the advisor is worth it as he/she can save you from lots of financial mistakes.
What is asset allocation?
While managing your assets, the only thing in your conscious control is asset allocation, which is in fact responsible for 90% of portfolio variability. The aim of optimal asset allocation is not to invest only in safe assets, but to invest in a combination of safe and risky assets whose combined risk is much lower than that of the individual constituents and, at the same time, offers higher returns. Further, each asset class itself has enough diversification. Individual items in the portfolio lose their individuality.
As assets move in business and economic cycles of their own and while one asset is in a bear market, another asset class may be in a big bull market of its own. Further, just as you have to constantly replenish and nourish your body, you must also periodically keep reviewing and refining your portfolio allocation with changing financial goals.
Think of investing as gardening. There is variety like asset allocation in a portfolio. When you are maintaining a garden, you will have to cut the weeds and prune the plants to ensure proper growth of the flowers.
What are good and bad assets?
Learn to recognize the difference between an investment asset (good asset) and a liability disguised as an accounting asset (bad asset). In simple terms, investment asset should produce income or bring cash to your pocket. Assets, disguised as accounting assets, actually take the cash away from your pocket. Think of those expensive cars, farm house, beach house, second home, club membership etc. – they all take cash on monthly basis on insurance, petrol expenses, drivers salary, maintenance charges, property taxes, utilities etc. Buying some expensive gifts such as jewellery or some other decorative art or item would also fall in this category of bad asset. Foreign trips, costly dinners or lavish parties are ‘unnecessary revenue expenses’ and should be avoided on the path to the financial freedom.
Buy good assets (income-generating assets) such as dividend-paying stocks, rental generating real estate, high yielding bonds, etc., which will give you the regular income in good or bad times. Buying some gold or gold Exchange Traded Fund (ETF) can provide you hedge against inflation. You can buy bad assets such as expensive cars, farm-house, gifts, decorative items or spend money on unnecessary revenue expenses such as lavish parties/dinners and foreign trips, etc. from the income earned from your assets – rental income, dividends, interest, etc. This will keep your assets constant and allow them to grow, while you enjoy your life.
Remember, “The best thing money can buy is more money. First, build your investment assets and then enjoy the fruits of it.”. You have to strive to reach such a stage where the income from your investment assets pays for your bad capital assets or for unnecessary revenue expenditure. That’s when you attain Financial Freedom.
How about investing in gold, diamonds, and parcel of land?
All these assets are to be called investing in ‘speculative assets’ (gold, diamonds, platinum, a parcel of land, etc.). Speculative assets yield only asset income (income on part or full sale of assets) as they are incapable of generating any running income. If you have the urge to allocate money to speculative items, do that only in limited quantities within your overall asset allocation. Piece of land, if used for some income generation (Agri income, rental income, etc.) will not be categorized as ‘speculative asset’ though.
It is advisable to always invest for running income because that gives you continuous income without sacrificing the investment itself. Also, if you truly invest for running income, it’s only a matter of time before that also generates asset income. Further, when you invest for running income, you’re not really concerned with the increase or decrease in the value of asset.
But, if you invest for asset income, you are continuously concerned about the increase in the value of assets because only then will you earn a return from your investment. As you own the cow for milk and, hen for eggs, you should buy the assets for their income-generating capability.
Is my home an investment asset?
Your home does not generate income or positive cash flow for you. Indeed, it consumes your cash or month-to-month basis for property tax, maintenance charges, and mortgage payments. While your home can’t be categorized as an investment asset (as it does not put income in your pocket), you should aim to own a home for self-occupation because it saves you ‘unnecessary revenue expenditure’ of rent, which does not result in the creation of any productive investment asset. It also saves you from the hassle of having to keep searching for new rental houses and related costs in terms of your time and money.
Remember that every expense of yours is someone else’s income and each one of your liabilities is someone else’s assets. The interest you pay on your mortgage is an expense for you and income for the bank. Similarly, your liability of mortgage loan is the bank’s asset. Therefore, your house is an ‘investment asset’ for the bank because it puts your money into the banker’s pocket in the form of mortgage loan installments.
Further, your house is a ‘real asset’ and over the very long term, notwithstanding fluctuations in the short and medium-term, the value of your house will rise relative to the artificial thing against which it is measured, that is, paper currency or money.
What fixed income products to look at?
If you need money in the next 2-4 years, the equity market or real estate should not be your choice. As markets could be down and real estate could be illiquid when you need money. There are many variants of fixed income products – Fixed Deposits, Employee Provident Fund (EPF), Public Provident Fund (PPF), Sukanya Samriddhi A/C, Post Office Deposits, Bonds/ Debentures, Corporate Deposits, GOI Securities, etc. You may like to choose some of these products based on your overall financial position and cash flows. Your Financial Advisor may help on the subject.
What is leverage?
Leverage, simply stating, is the ‘multiplier’. Like cholesterol in the body, leverage could be positive or negative. If you use leverage (borrowing) to buy investment assets, it will help you grow your asset base, generate income and compound the wealth over a long period of time. On the other hand, if you use leverage to buy liabilities disguised as accounting assets such as farmhouses, big cars, and lavish homes, it will compound your debt and put you in a debt trap in the long run. This means, positive leverage is that debt which multiplies your wealth, while negative leverage is that debt which multiplies your liabilities.
Never use leverage to buy a liability disguised as an accounting asset, because it will not only take money out of your pocket in the form of maintenance and running expenses, but also in the form of interest payments on your debts. Similarly, leverage should not be used for any consumption – Foreign travel, expensive dinner and lavish parties. Remember, both positive and negative leverage compound in the long run.
What is compounding?
If you put Rs. 100 in the bank at time 0 @ 10% per annum. At the end of the year, money becomes Rs. 110 (Rs. 100 as principal and Rs. 10 as interest). If you leave the interest with the bank itself, next year, the bank to give the interest of 10% not only on Rs. 100 but on Rs. 110. It means, your interest amount will keep going up with every passing year.
If you leave the money in the bank for a long time, your money will see a multiplicative effect and that is called compounding. Einstein called compounding the eighth wonder. Investing is all about compounding. And, to enjoy the fruits of compounding, one should start investing as early as possible.
Is Equity the real tool to build wealth?
Yes! List of Forbes 500 wealthiest people hints that Entrepreneurs are the wealthiest lot. Therefore, to create real, sustainable, long-term wealth, one has to either build a business or participate in such a business through equity participation. Indeed, buying equity means investing in a part of a business. Also, understand the difference between risk and volatility – equities might be volatile in the short term but provide higher returns with much lesser risk over the long term.
The equity market is an ocean and one can draw as much money as one wants from the market. However, this ocean can also suck as much money as you have into it as the market is primarily designed for people to fail. If you don’t have knowledge, don’t ever invest directly in equity. Don’t go by tips ever. You may like to access the market through professional fund managers – Mutual Funds or Portfolio Manager Service providers.
If you have the urge to invest directly on your own, then Index Funds or Exchange Traded Funds could be your best bet. Always exhibit prudence, discipline, and patience in dealing with the market.
What do you look for in the businesses while investing?
In recent master class of Mr. Bharat Shah, he beautifully stated “Markets are ‘forward looking machines’, pricing assets based on discounting of future cash flows to the present. Therefore, while investing in equity, 95% of your time should be invested in understanding future of businesses.”
Investing is all about the preservation of capital and then its appreciation. Markets are beautiful compounding machines if we are ready to work hard in analyzing businesses. Some contours of investment-worthy businesses are:
- Quality of business – There is no substitute to the good quality. Look for competitive Advantages/Moats in the business. This will work as shield preserving your Capital in the long run.
- Long runway for growth – Look for large opportunity space and ability of the company to address the opportunity. This is to ensure that business is scalable and grow over a long period of time. Growth will create Capital Appreciation.
- Longevity of business – Close your eyes and visualize whether you see business being relevant and existing 10 years down the line. If yes, this would create a compounding factor in capital appreciation.
- Bargain value – This is about ‘Margin of safety’, Value being higher than the Price. It provides one time advantage at the time of investing.
- Quality Management – Honest and competent management is important as your partner in the business.
How to look at the Valuation of Businesses?
The low price of a share doesn’t mean cheapness. Similarly, the high price of a share doesn’t mean it is expensive. The price needs to be compared with its value.
Value, as Mr. Buffett said, is an independent judgment of an individual based on the estimated earning potential of the asset-backed by his accumulated knowledge and experience. People try to find the value based on the discounted free cash flows of the asset over the next few years. While doing so, you should be cognizant of the fact that estimating the free cashflows of a business for the next 5-7-10 years is, if not impossible, a very difficult task.
As an alternative to hard work on estimating future cash flows, people use price-to-earnings ratio or price-to-book value ratio as the valuation metrics. One must remember that these two ratios are backward-looking matrices to value a business and don’t communicate anything about its future potential.
What is the difference between investing and speculating?
An investor chases value while a speculator chases price. Anyone who buys/sells shares, operates in the derivatives market, with understanding or without, with his/her own money or borrowed one is called ‘Investor’. This is a fallacy. Investing means you know what you are doing. Speculators can make money in the short run but are sure to lose in the long run. Investors may incur losses in the short run but are bound to make money in the long run.
Emotionally, if you can’t see your investments depreciate by 50% over the short term, then equities probably might not be the right thing for you. The nature of equity investing has to be long-term.
What is nature of Mr. Market?
The DNA of Mr. market is volatility. Markets have been volatile and will continue to be volatile in the future. In the short run, the ‘emotional disorders’ of market participants make the ‘Rationality’ go out of the window, but, in long run, rationality wins over emotionality. Make volatility your friend.
Understand the difference between price and value. And, remember that while the prices could be very volatile, they merge with the value in the long run. Appreciate that the best investment returns are made in the worst of times. Try to buy into high-quality, dividend-paying companies with prospects of earning growth which might be temporarily going through the problem due to an overall unfavorable business environment.
Markets have their own methods of finding and exploiting human weaknesses. Therefore, they are designed for the people to fail. Beware of them. Patience and persistence make an unbeatable combination for success, whether in life or with equities. There are very important lessons to be learned from history and bear market bottoms. Spend time reading the history.
Is insurance an investment?
Insurance is to protect you from any untoward incident in life. It is not an investment at all. Therefore, never combine investments with insurance. The major categories of financial insurance include term insurance (family protection), disability protection (family and self-protection in the event of losing your income-earning capacity), medical insurance, asset insurance and loss of profit protection in the business.
If you were to die today, you are going to leave behind only your investment assets and insurance money. Indeed, you should build adequate protections before you embark on your wealth creation journey.
What are decision fallacies?
Throwing good money behind the bad money is a sunk cost fallacy. I remember buying the shares of a company at each falling level to reduce my overall cost. Holding on to losing assets just to avoid booking the loss as ‘mark to market losses’ are less painful than the ‘realized ones’ is the ‘loss avoidance fallacy’. Not taking a decision is the decision to maintain the status quo – ‘decision paralysis theory’.
While all progress is made by contradiction and not confirmation, most of us look for confirmations to our thesis as we don’t want to prove ourselves wrong – called ‘confirmation bias’. Treating money received as a gift or won in a competition-free is a ‘Mental accounting fallacy’. All money received is equal and to be respected accordingly.
What is financial freedom?
Financial Freedom means you don’t work for money but for passion. It means you move from “having to work” to “choosing to work.” When your money works hard for you and your passive income is able to take care of your day-to-day expenses (negative operating cash flows) without compromise with your standard of living. Wealth needs to be built dollar-by-dollar, and it takes around two decades of money discipline to be ‘Financially Free’.
Freedom is the ultimate goal of every soul and the same can’t be experienced until you accomplish ‘Financial Freedom’. Money is not the solution to your problems, financial knowledge is.
Book states “Problem with people is that they spend more than they earn, they are not able to protect themselves from financial predators, they buy liabilities with negative leverage believing them to be the asset and fall into the debt trap, becoming slaves to EMIs and money for life.”
The most important lesson in the book is “Man’s biggest regret while dealing with money are to earn without protecting, to spend without budgeting, to save without investing, to invest without learning, to grow money without leveraging, to work without insuring, to die without living.”
The book ends with some wonderful lessons on life – “We are spiritual beings going through the human experience. Nothing in the world has the power to hold you back other than your own self.” We are here on this earth with the purpose to serve humanity with the best of our capabilities and resources. And, to live 100 years, we don’t need to essentially live for 100 years; We need to do great work so that people remember us for the next 100 years.
To conclude, my realization is that people top in school and fail in the real life. All professional degrees are designed to teach people ‘How to earn money,’ not ‘How money can earn money for you to enjoy life to the fullest.’
Many educated people are financially illiterate. Financial Literacy is a different language, which is not taught anywhere; it is learned by the seekers. Acquiring ‘financial wisdom’ is your own responsibility. ‘Financial Nirvana’ is your birth-right.
Building wealth is a marathon, not a sprint. It’s a boring, long-term project. And it’s a game of discipline and delayed gratification to save judiciously, invest prudently and wait patiently while the money creates the compounding magic. The commandments stated in the books are to be understood, appreciated and lived throughout.
Wish you a great success on your journey to “Financial Nirvana”.