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How to double your money in 3 years

August 18, 2004 11:33 IST

Our intention in this article is to highlight the dangers of being carried away by cover stories in the 'media' on how to double your money in three years.

Investing in the stock markets, either directly or via equity mutual funds, is unlike gambling, where the result depends entirely on luck. While investing one can minimise his/her risk by undertaking due diligence of the stock or fund and understanding its long-term prospects. Of course there are risks in investing too. No doubt about that. But if you do your home work well, you can reduce your overall risk.

Having said that, equities as an asset class carry high risk. Just because the markets look attractive from here (a hypothetical case), does not mean that the risk associated with equities has reduced. So, if you are 55 years of age, and looking at retirement in the next couple of years, be very careful of all the fancy ideas about doubling or even trebling your money.

Within the equities asset class, smaller companies (and mutual funds that invest in such companies) tend to carry higher risk as compared to their larger peers. This is largely due to the fact that smaller companies are yet to establish themselves well, have limited track record and many a time, very limited information about them and their management is available.

To put this 'risk' in perspective, a leading fund which invests in small and medium companies, Franklin Prima Fund, declined by 48.5 per cent in year 2000 even as its benchmark the NSE Nifty fell only 29.3 per cent. On the other hand, Franklin Bluechip, a fund which invests in large companies, fell only 19.2 per cent in year 2000. Conversely, in a rising market, Franklin Prima tends to perform much better than Franklin Bluechip.

Now coming to the doubling or trebling or quadrupling part. Doubling in three years implies a compounded annual return of 26 per cent per annum. This is not impossible. As most seasoned investors know, in the stock markets, nothing in impossible (to skeptics - Hindustan Lever is trading at Rs 107!). But the question is whether such a return is likely and if yes, at what risk. If you understand and can absorb the risk (very important), go ahead take it.

This leads us to the next point, which is equally important.

Know the person from whom the advice is coming. Is the advice coming from a journalist or from a seasoned analyst? If from a journalist, has he made a call on the basis of his interactions with 'experts'? If from an analyst, what is his track record? What are the arguments put forward for this aggressive call? And does the journalist/analyst have a position in the stock or has he/she transacted in the stock in the few weeks preceding the note/article. If you are unable to take a view on this, we recommend that you get in touch with an investment advisor.

Finally, it is very pertinent to understand and appreciate that in the stock markets there is a possibility that perceptions about a company can sometimes take very long to change. To explain this further, suppose you identify a company, based on some study that you have done, whose stock price is likely to double in the next three years. What could happen is that even though the company's financial performance may be in line with what you expected its valuation (or stock price) in the stock market may not grow in tandem. So the doubling may take longer, or may not happen at all!

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