Stay true to basic principles

With the benefit of hindsight all of us are great investors. We precisely know that we should have begun to invest when the...

With the benefit of hindsight all of us are great investors. We precisely know that we should have begun to invest when the markets bottomed at the height of the panic last November. Our current reality though is that we are sitting on cash and hoping for a market correction,while equity markets seem to be scaling new heights. If there is a key lesson in the global market crisis of last year it is that we have survived and are still able to earn,save and invest,while the rest of the world is still licking the wounds from the onslaught that threatened to become a full-blown depression.

It is quite natural for investors to believe that the matters that should concern them are how US deficits are moving up,how Japan may take longer to come out of recession,or understand the implications of government borrowing on the Indian bond markets. Many think that such analysis is a fundamental pre-requisite to managing their portfolios. The truth may be simpler. Investors perhaps need to spend more time on their own personal finances. If they find that their jobs,income and saving have not been impacted by the fury of what was happening elsewhere in the world,they were enjoying a beautiful diversification benefit even if the local stock markets went crashing with the global markets. To have money to invest when the market offers an opportunity to do so is more valuable to wealth creation than scholarly knowledge of markets.

Boom time excesses

Personal finances surely are on the mend. Those who were impacted most by the crisis were the households that had grossly exceeded the limits of financial prudence. If credit card spends did not take into account the risks to future income,or if homes were bought taking up 60 per cent of the disposable income as EMI,or if margin funding from brokers exceeded the ability to pay,such investors were taking risks they were ill-equipped to take. A crash in the price of houses and stocks naturally pushed them to the brink of bankruptcy. If we now have the much shunned 1-BHK 1 bedroom hall kitchen apartment masquerading as the hottest new studio apartment,we have the market crash to thank for bringing in the reality check.

Return to basics

The biggest benefit of the crisis is the return to basics. It warms the hearts of the academic-oriented like yours truly. Speaking to investors about diversification,asset allocation and risk management sounds all so theoretical in the boom years. It takes a crash for the erstwhile experts to come back to the classroom. Grabbing the opportunity to hold forth,I never fail to point out that strategic asset allocation that is close to the investors own situation is the core principle in investing. It has little to do with markets or their levels. Most of us make a mistake when we do not see tactical calls on markets as a mere overlay to basic underlying strategy. Many investors think that they can time markets very well,and indulge in tactical shifts from time to time. This is why they may now find themselves out of equity and holding cash,even as the equity markets seem to have bottomed out and are on their way up again. That is also why they may be placing all funds in retail bonds now,locking their funds beyond five years at a rate that can quickly get unattractive when equity markets begin to outperform.

Producers sell what sells

That brings me squarely to the choice of products in the market. Investors believe that if they bought the right stock or bond or mutual fund,they would do well. This tendency could work against the interest of investors. Producers,including mutual funds and insurance companies,will introduce products that sell. Therefore the frenzy for infrastructure funds will increase when interest in the product is the highest; commodity funds will come at the peak of the commodity boom; ULIPs will be pushed aggressively in a bull market; and bonds will be sold when investors seek certainty. It is in the interest of the producer to sell what is sought after. Investors should desist staking all in current favourites in their eagerness to make money. Investors who seek the safety of bonds now should ensure that they dont exceed their basic allocation. The need for growth or safety is a function of investor preference,not market movement.

How much risk can you bear?

That brings us to the question of risk. The risk investors can assume is based not just on their willingness,but ability to bear risks. An eager investor who has just begun might be taken in by the fancy of buying a private equity fund,or invest in a property deal that is hard to resist. But the return in a private equity fund is based on the premise that a few of the many projects funded turn out to be multi-baggers. Choosing the winning stock is tough and choosing from a bunch of start-ups is even tougher. Investors need to be on the top of the wealth pyramid,able to bear these risks,to choose such products. Risking the little that they have may leave property investors with so little liquidity that they may pile up expensive credit card loans. Investors have to be cautious when flooded with persuasive product literature.

Is there is a new lesson that the crisis has taught? Not really. It is just that the old lessons seem to have been taught to a whole new bunch of investors who felt that making money and becoming wealthy was easy,since the world seemed to favour their prosperity. The crisis has only served to ground such unrealistic expectations. The waves will continue to lash,in high and low tide. How well we sail depends on the boats we have and our skills in judging when to set sail. There is no wisdom in blaming the sea and its fury.

Story continues below this ad

The writer is MD,Centre for Investment Education and Learning

uma.shashikantciel.co.in