Everything you know about money is wrong

April 12, 2010

KARACHI: If you are like most Pakistanis, you probably do not have a mutual fund account, a brokerage account or even a life insurance.

You all may have your own reasons. Some of you may not believe in such things for religious reasons. Others may simply not know of their existence. Still others may be intimated by the complicated jargon of finance. But all of those reasons are wrong. And it is about time somebody told you so.

Over the past decade, the financial services sector in Pakistan has nearly quadrupled in size and yet, it remains a sad fact that nearly nobody in the country seems to know anything about managing their own money.

To be sure, there are many competent bankers in the country who could tell you exactly how to manage the finances of a multi-million rupee enterprise. But most of them would be clueless when it comes to advising an average individual about their personal finance. This column will seek to begin what appears to be one of the first attempts to educate the public about personal financial management.

I will begin with an assumption of utter ignorance on the part of most readers. Here are some of the common myths you might hear on the off-chance that somebody decides to advise you on how to manage your money.

“The entire financial system is controlled by a vast Jewish conspiracy.”

If you seriously believe that, please stop reading right now.

This claim, which appears in various iterations almost everywhere one begins to talk about financial institutions in Pakistan, is so ridiculous that one need not even dignify it with a refutation.

“The stock market is a giant casino where small investors only get swindled.”

Of all the myths out there, this is perhaps the most insidious and one that is usually perpetuated by people who do not have a clear idea of what a stock is.

Simply put, a stock represents an ownership stake in a company. The company is not promising you any returns, nor even your money back. It is risky to invest in stocks, but the returns are far greater than any other type of asset.

To the idea that the stock market, particularly in Pakistan, is rigged towards the bigger players, one would acknowledge this as partly true. Insider trading is rampant on the Karachi Stock Exchange. But that does not mean that the average investor cannot make money in it. Indeed, despite this fact, the stock market remains the single best way to grow one’s wealth in Pakistan.

As proof, consider the following fact. On January 26, 2009, the KSE 100 index stood at 4,811 after having dropped over 69 per cent since its peak of 15,676 reached almost nine months earlier. Yet even at that dark hour, the stock market had a 10 year average return of 18 per cent, more than quadrupling the money of the investors who had put their money in ten years ago. Beat that.

“It is better to be safe than sorry with your money.”

This advice is actually true, but only for people over the age of 60. For anybody younger, a little amount of risk is almost always justified. For anybody under the age of 30, if their entire savings are in a current or savings account at a bank, there is something seriously wrong.

Young people can afford to take risks and should invest mostly in stocks, either directly or through equity mutual funds. Remember the cardinal principle: greater risk usually corresponds with a greater probability of returns. This does not mean being stupid, of course. But a well-diversified portfolio that involves some risk is generally a better bet than a portfolio that relies entirely on safe assets.

“The financial services sector is too complicated for me to understand.”

Most finance does not involve anything more than basic mathematics that a sixth-grader could understand. But the difference between knowing and not knowing can be the difference between getting richer over the span of your lifetime and constantly struggling to meet the major expenses of life.

This column will seek to demystify finance in a specifically Pakistani context. Next week we will continue with debunking some myths before moving on to more substantive topics. So please keep reading. It may just be worth your while.