Rakesh Jhunjhunwala enjoyed a cult following in the stock market. Whatever he bought, sold or told on TV channels became headlines. People wanted to listen to him to learn from him. We have already compiled a list of things that you can learn from him. However, one cannot copy him completely. Some of the traits he possessed were unique to him and cannot be emulated. His leverage-driven investment style was too risky. It is just that he managed to handle his risks well. Not everyone can be as astute and as disciplined as he was in his investment process. We shall now discuss the things you should not learn from Rakesh:
Rakesh would borrow money to invest in the market so that he could take large positions for larger profits.
While he could manage his debt, he never advised others to follow this approach. Investing in the stock market on borrowed capital is one of the sure-shot ways to get poorer. In fact, in his keynote address to students at FLAME University in 2009, he talked about his wish to reduce his debt. ‘I want to get deleveraged, but hota nahi hai (it’s hard to do it). If I have bank balance, I can’t sleep well. If I pay interest, then only I get good sleep,’ he says.
It had become a habit for Rakesh to invest on borrowed capital and pay interest. In fact, in one of his interviews with Ramesh Damani, he claimed that he had deployed only Rs 1 lakh in trading; the rest was the borrowed capital. He boldly claimed often that he earned his wealth from the long-term investment through trading. Rakesh’s story may inspire you to do the same. However, it is not meant for all. For him, it was a passion. This is what he did, thought and talked about all the time. He mastered it. A regular investor, whose primary job is different, will not have the time and the mind space to emulate Rakesh’s trading style.
For retail investors, borrowing to trade is not a great strategy. The market can be irrational in the short run, longer than you can stay solvent—even if you’ve made the right bets. Leverage forces you to either book a profit or get out of a trade in the short run. Without leverage, what would your returns have been? Let’s understand with an example of the Sensex. A sum of Rs 561 invested in the Sensex from1986 to 2022 would have become Rs 59,842 on 16 August2022. But most people get regular monthly income from a salary and they tend to invest every month through an SIP rather than starting off with a lump sum amount and never adding to it. So if you had set up a simple SIP of Rs 5000 per month in the Sensex over this period, it would have built a corpus of Rs 6 crore. If you had increased this SIP by 10 per cent every year, the money would have grown to 13.1 crore. Do these amounts seem low to you? You may know middle-class families who have built much more wealth than this by investing similar amounts twenty or thirty years ago in plots of land or flats. However, the secret to their fortune is also the same as Rakesh Jhunjhunwala’s—leverage of debt.
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The typical home buyer would put down20–30 per cent of the cost of the property as down payment and pay off the rest. This increases your starting capital. Let’s assume that you bought a house for Rs 20 lakh in1993 and put down Rs 5 lakh of your own money and borrowed the rest from a bank (Rs 15 lakh). The value of this house grows at a rate of 12 per cent over the next thirty years and your interest rate over the same period is 10 percent. The value of this house would now be Rs 6 crore. Even adjusting for loan repayment with interest (a total payment of Rs 47 lakh if you had opted for thirty years), this value is much higher than a stock portfolio that grows at 12 per cent over the same period. A stock portfolio of Rs 5 lakh growing at 12 per cent over thirty years would attain a value of 1.5 crore. Why did this happen? The loan of Rs 15 lakh acted as a magnifier—it pushed up your overall wealth creation. However, leverage is by no means a good thing. A problem with the underlying asset—let’s say a land dispute in the case of real estate or an un delivered flat—can send leverage into reverse, magnifying your losses rather than your profits.
This excerpt from ‘The Big Bull of Dalal Street’ has been published with permission from Penguin Random House.
The late Rakesh Jhunjhunwala was an investor with ThePrint.