Pareto's Principle - The 80-20 Rule - Vital Few and Trivial Many

Pareto's Principle - The 80-20 Rule - Vital Few and Trivial Many

29/01/2013 by Padmanaban Balasubramanian

 

This principle holds good for everywhere. 80% of the populations are working for 20% of the people, and 20% rich are holding 80% of the globalwealth. This Pareto's Principle perfectly fits our day to day life also, which many of us have not thought about this before.

Assume, the individual is earning 50K per month and he spends 80% which is 40K towards all the expenses and he hardly saves 20% of the money which is 10K per month. Let's take the individual, goes to job at the age of 21 onward and got married around 25. If he plans, to retire at the age of 55, which means he is going to work for the next 30 years. For every increase of salary, there is a proportionate of increase in spending or more. For calculation purpose we will assume salary and savings are constant for the next 30 years.

The amount one will earn in the next 30 years will be 1.8 Crore (50,000*12*30) of which 1.44 Crore will be spent to maintain the same standard of living. The savings part is 36 Lakhs only.

After 55 (most of us are working for private, we are not entitled for any retirement benefits), either there will be no income or lesser income. Whereas the 20% of 50K which is 10K per month in a period of 30 years at the rate of 15% CAGR will fetch you 7 Crores, in case of 12% CAGR it will fetch Rs. 3.52 Crore, which they will not even earn during their tenure of 30 years. Look at the power of compounding to double the returns, and it requires only 3% more not 24% CAGR. SENSEX has given 17% since inception, and the entire top rated funds has given more than 20% CAGR yet, I always tell that you will get 15% CAGR in the long term to manage your expectation.

Where the problem lie here is, most of not even saving 10% regularly, in the above example if they save 10% then still they can generate 3.5 Crore at the rate of 15% CAGR, and the same money what they have earned during the tenure of 30 years at the rate of 12% CAGR.

This helps to understand where we stand and how to change our spending habits to create something for our rainy days.

Creating wealth is a child's play and it requires only one thing which is called discipline.

When you need something first you have to give, unfortunately people will not invest anything but expect returns.

I remember this saying "Everybody wants to go to HEAVEN, but nobody wants to DIE".

Power of Equity Mutual Fund Returns Will be Realized in Long Term only, say 10 plus years!!!

One Lakh rupees invested in HDFC Equity Fund on 25th April 2001, in a dividend reinvestment option and the first dividend declared was Rs. 11,194.03 on 16th March 2002 and the fund was switched to Growth mode on 1st April 2002. By the time Rs. 1 lakh has grown to Rs. 1,26,574 almost 27% in one year time. (See the PDF attached, for better understanding).

This particular statement was generated on 10th October 2012 and that day prevailing NAV was 276.832 and value reads Rs. 15,51,124.85.

As on Friday (18/01/2013) HDFC Equity Growth NAV is 303.213. If you multiply this NAV to the existing units of 5603.127, you will get Rs. 16,98,940.94 (Sixteen Lakhs ninety eight thousand and nine forty rupees and ninety four paisa only).

This fund has generated 27.26 CAGR for the past 141 months.

The SENSEX was closed on 3600 on 25th April 2001, even though this fund was not benchmark with SENSEX, most of the investor will know only Sensex value and they always quote I invested when SENSEX was at this level and now it is more than that level so I want to redeem.

In other words Sensex value 3600 (24/01/2001) grows to 20040 level (18/01/2013) on Friday which means it has grown 5.56 times (CAGR 15.73) as against the fund grows from 1 lakh to 17 Lakhs (approx.) which is 17 times (CAGR 27.26)!

My Observation based on the above Investment as follows...

1. All along I was showing only the fund returns, not the investor returns because investor hardly stays in equity market to enjoy the fruit.

2. This is one of my client (recently acquired) portfolio and still it is active and I have changed the client name to my name and all the sensitive data’s are changed to avoid any compliance issue. People have more conviction when they actually saw the statement of account that is the reason I have attached the same.

3. This is not the only fund generated such a huge returns, nearly dozen funds has given the same return or more return than this. But, I have statement for this fund only.

4. The beauty of the investment is no need to pay any tax and the investor can enjoy all the money, which reminds me the sayings patience pays...

5. This is the not the mail to promote this fund or this kind of return one can expect in the near future also, and being a financial planner my duty is to explain how powerful diversified equity funds are when you have invested long, especially for our long term goals like children education, marriage and retirement etc.

6. Don't always look at only SENSEX value, because the amount you invested most of the time will not replicate bench mark of SENSEX. Moreover, the fund manager has got the ability to create more alpha (more returns than benchmark they have chosen).

7. Sensex closing price on 18/01/2008 was 19013 and exactly 5 years later the Sensex closing price on 18/01/2013 was 20040 which mean CAGR of 1.05% in the last 5 years.

8. HDFC Equity Fund Growth option NAV was 207.76 and today it is 303.213 which are CAGR of 7.85% as against SENSEX CAGR of 1.05%. In the SIP mode for the last 5 years (60 months) the amount invested is 2000*60=1,20,000 and the value today is Rs. 1,81,310 which is CAGR of 15.33%.

9. Mutual Fund investments are well regulated and unfortunately the investors are not willing to take part the way they took part in real estate and GOLD.

10. Based on the above facts and figures I strongly believe that 15% CAGR for the next 5 years is almost you can take it for granted. Hope people have witness the trailer in 2012 for equity returns.

The entire analysis is to show how big this particular investment vehicle is and it is meant for masses (poor to rich). I reiterate once again that mutual fund is the only route in which everybody can create a huge wealth over a long period.

My First Program in Sun News Varthaga Ulagam on 12/01/2013

https://www.dropbox.com/sh/63fhlxfqouud52u/FzmxqKm9rt