Meanwhile Manju had five years of pure fun at Xaviers before starting work at an Ad agency. They met at the school alumni meet in 2001. Manju thought it fit to ask Anju for some tips on investments. Manju had invested all 4 lakhs of her savings in a bank FD at 7 %. Anju was flabbergasted. She wanted to be of help to Manju. “You see given that inflation is at 4 % you are in effect only getting a Real rate of return of 3 %”.
Cut to 2006. One more reunion. Anju’s stocks had performed brilliantly. She earned a “CAGR” of 24% she told Manju. As usual Manju didn’t understand a word. “So you must have moved into that large flat right” Asked Manju.
“Alas, real estate rates have gone through the roof, that flat is still unaffordable” Anju Said.
Slowly Manju started understanding what “real” returns meant. Car prices had crashed. An affordable bank loan coupled with Bank FD had allowed her buy a Honda City. In real terms she had performed better than Anju who could yet not buy her dream house.
Anju went home feeling jealous. Everything had gone well for her. Seemingly. Yet Manju the financial dud had done much better for herself. Over the next few days she thought of only this and nothing else. To the point where it got unbearable. She decided that she had to go back and speak to her B-School Prof. to figure out what went wrong.
Professor Tsunami-nathan intoned, “While inflation of consumer items like foodgrains, clothes and other items of everyday use has been moderate, capital assets like real estate equity and gold have risen in value substantially.”
“Under such circumstances, is it not silly to hold on to the Real Returns = Nominal Rates minus Consumer price Inflation formula? Especially when consumer price inflation rate does not reflect the huge increase in capital asset price.” asked Anju.
“Its as silly as the statistician who drowned in a river whose average depth was only 4 feet. He believed that being 6 feet tall, he would have no problem crossing the river, till he reached the point where the river was actually 12 feet deep” replied tsunami, with a grin that did not hide his contempt for Anju
“The inflation rate is merely an average. The average, as you are aware can conceal huge variances in the rise in prices of individual components” Tsunami went on.
He never had patience for the student who applied formulae without understanding the underlying assumptions. As corollary, he did not really enjoy discussions with his students, supposedly the intellectual cream of India
“To believe that booming stock markets have made investors as wealthy as these pink papers make us believe is absurd. A person’s wealth increases when he can buy more with what his investments generate for him. In fact the next time the stock market falls by 20%, you may actually become wealthier,” he said.
And Anju being the quick learner was quite clear. “If that flat that I want falls in value by 50% and my stock investments only by 20%, I may in fact be able to buy it.”
She went home and prayed that her dream house becomes affordable. Unlike earlier, when she prayed that her stock investments rise in value. She did not care for the nominal value of her shares any more, she was only interested in what they helped her purchase.