Tuesday, January 25 2022

Playing with your wallet is not recommended and is harmful to your financial health!

Indian markets are reaching historic highs! Nifty 50 has passed 17,400 and BSE Sensex is approaching 60,000 levels. Few of my friends in a school B WhatsApp group ask this question every time Nifty increases 1000 points. He was asked when Nifty cleared 15,000 levels, then to 16,000 and it repeated at 17,000. What should I do? Should I recognize the profits?

My answer has always been the same: why do you need to do something? And it doesn’t fly well. No-action advice is apparently not good advice. When he didn’t seem convinced, I told him not to look for excitement in his long-term wallet. I further advised him to have a separate trading portfolio where he can research all his thrills or maybe join me for a game of poker and get his dopamine fix!

The advice to all retail investors (HNI included) is to follow only a few boring principles consistently over a long period of time. This is the hardest part – consistently.

Here are these seemingly boring but simple and effective principles:

1. Goal setting: This is the first but most important step in an investment plan. Whether it’s creating an emergency corpus, buying a home, or planning for retirement, all goals should be included when planning. If your advisor doesn’t ask you what your goals are, switch to another advisor.

Not having goals in your plan is tantamount to planning for failure.

2. Risk profile: The risk profile is both the willingness and the ability of an investor to take risks. Ignore these two at your own peril. The capacity or the risk capacity is easy to determine. Willingness to take risks or aversion to risk matters as much, if not more. Many investors panic and sell stocks when markets see significant downward movements – such as in March 2020 with the first wave of covid. As unpredictable as the markets are, they are rebounding but most of these investors sit on the sidelines hoping that the markets will restore them to an entry level. Even geniuses cannot time the market consistently and consistently with success. The role of an advisor takes on all its importance here: to ensure that the investor ignores short-term volatilities in achieving his long-term objectives. Otherwise, investors remain under-allocated to equities for a long time.

3. Asset allocation: How much to allocate to stocks, bonds, gold? It depends on the risk profile and the duration of the goal. For the less than 5 year goal, the allocation to fixed income and gold should be higher than long term goals. Maintaining the asset mix is ​​essential and the advisor should also adjust the asset mix as the goal gets closer. Regular rebalancing ensures that the over-allocation and under-allocation to a given asset class is corrected. Tactical asset allocation (if any) should be exercised with caution.

4. Underlying investments: Have more allocation to passive index funds than to actively managed ones. Predicting which strategy and which manager would do well is like predicting the markets – it is very difficult to be right. The savings in terms of reduced costs are also significant. Our estimate suggests that average returns on equity portfolios could be 14-22% higher in absolute terms over long periods (20 years) while in a passive portfolio. So Rs. 1 cr portfolio can be from Rs. 14 to 22 higher value lakes by simply switching to lower cost index funds. The bond allocation can be completely devoid of credit risk, except in situations where credit spreads are really attractive. Gold sovereign bonds are the best way to invest in gold.

Most advisers would stop here and leave out a very important principle.

5. Ignore the noise: Everyone is too often inundated with information about this pocket heck (cell phone). Global financial crisis of 2008. The collapse of emerging markets in 2013. Trump won. Trump lost. No to Brexit. Yes to Brexit. Covid 1st wave, 2nd wave, etc. Investors should be aware of what is going on but not necessarily take action in their portfolios. Equity markets are volatile but eventually recover.

Investing, as they say, is 90% emotions and 10% skills. Therefore, I am going to take inspiration from the bestseller of the famous economist and Nobel laureate Daniel Kahneman “Thinking fast and slow”. According to Dr. Kahneman, a part of our brain reacts spontaneously (System 1) to any event and activates automatically without any effort. When we get a juicy tip offering attractive returns from a friend or broker, System 1 pounces on it and makes the individual act on it without thinking deeply about its pros and cons. What we need to do is work on System 2, that part of the brain that processes more information and gives a more nuanced view of the situation and the decision to be made. It is difficult to activate and therefore less used. Focusing on the 5 principles mentioned above will help you be less responsive and use System 2 more often.

My question to readers is, could you predict the market levels for March 2020 (Nifty 50 at ~ 8000) or could you predict that the market would rebound so quickly from its lows. The thrill of going right is high, but the chances of being right are really low. For that thrill, one could create a small trading portfolio (although not recommended) as it does not affect any of your goals. However, I would suggest doing adventure sports for the thrill. Unnecessary portfolio manipulation is detrimental to financial health. It causes long-term heartache. Similar to a pack of cigarettes, this can be a mandatory warning when investors buy a pack of stocks



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Disclaimer

The opinions expressed above are those of the author.



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