Live Mint, Mar 31, 2020
Identify stress points such as inadequate income and reset of return expectations from different assets
The new financial year has started on an uncertain note—of a kind that you may not have dealt with earlier—with the seismic effects of the covid-19 pandemic likely to be felt across the economy, jobs and livelihoods. The tumult in the real economy has communicated the stress to the financial markets too.
The long-term investment horizon suitable for equity that was anything over three years depending upon who you spoke to briefly expanded to over 15 years if you wanted to earn better returns than what a bank savings account gives. Liquid funds that were seen as alternatives to bank deposits are suddenly giving negative returns, while government-backed fixed-income products have raced to the top of the return charts.
With a new normal emerging as you embark on a new financial year, how do you navigate through these uncertainties? We try and give you some answers.
Control what you can
In times such as these, it is important to focus on what you can control. “When you have too many worries and uncertainties related to your job, income and portfolio, among others, you should strive to convert some of the variables into constants,” said Amit Kukreja, founder of Amitkukreja.com.
“Moving the portfolio to more secure assets, such as high-quality debt, is one way of doing this,” he added. Increasing allocation to debt will not only allow short-term goals to be met with certainty but will also give time to the equity investments to recoup their losses.
Protecting the household’s income in a period when livelihoods are at risk is important. This is the time for the emergency fund to come into its own. Build a corpus worth at least six to nine months of expenses and liabilities. Until you put this in place, keep other investments in abeyance. Earmark easily accessible existing investments such as bank deposits and debt funds for this purpose to get to the target quickly. But be cautious in doing so. “Be realistic about your situation and your essential needs. If you magnify the problem then it may lead you to take decisions such as stopping or pulling out of investments at a loss, which may harm your financial situation,” said Roopali Prabhu, director and head of investment products, Sanctum Wealth Management.
“If there is unpredictability in income, it is important to keep liabilities low and have an adequate emergency fund,” said Deepali Sen, founder partner, Srujan Financial Advisors LLP.
Assess your situation
The avalanche of news and information, mostly bad, can lead to hasty decisions that may not be in your best interest. Tune out irrelevant external noise as much as possible and instead focus on your personal situation.
If your job and income are secure and there is no change in your risk tolerance, your investment plan can remain the same more or less. If equity forms a small part of your portfolio, sharp market plunges won’t be relevant and can be largely filtered out of the decision-making process. Focus instead on your goals and the changes you would need to make, such as increasing the periodic investments, given the present situation.
Sen reiterated the importance of focusing on each person’s distinctive situation and its implications before taking actions that have far-reaching financial consequences. If a lower equity allocation suits you, rebalance the portfolio by allocating investible surplus to the asset class that you want to add to. “If, as a result of external factors that you cannot control such as a loss of job or the excessive volatility in markets, your risk appetite has changed, then it is important to cater to it by adjusting the asset allocation,” said Sen. If your goals and risk appetite have not changed, then continue with your planned investments.
Identify stress points such as inadequate income, a reset in the returns that you expect from different asset classes and the investment horizon required to reach goals and change in risk tolerance. Build corrective actions into the plan and review the progress periodically.
Face the reality
A typical reaction to uncertainty is to find short-term solutions and ignore the long-term impact. When you sell during a market crash and move into cash, you may be able to protect your portfolio from short-term volatility but may risk your long-term goals by holding on to cash.
“Making long-term allocation changes based on one negative experience, however significant, may not be advisable,” said Prabhu. “If you have gone through past cycles of market volatility and recovery, you know that at some point in the future, the market will bounce back. And that is why when planning for goals, we must always keep the investment horizon in mind and invest accordingly. So, for goals that are at least five years away, we will continue to hold equity and, if possible, add money to it,” said Kukreja. But experts added that investment decisions that don’t lead to peace of mind need to be reconsidered.
A crisis brings to the fore the importance of sticking to processes such as having an asset allocation that reflects your goals and risk tolerance, staggering investments into a diversified portfolio and rebalancing assets periodically. When you rebalance the portfolio to a trigger, say, a variation of 10% from the preferred allocation, you are able to book the profits and reduce your exposure to a volatile asset class. As such, the portfolio is less hurt when there is a steep fall. It will also help you enter the market at lower levels, if your situation is conducive for this.
Investors who have been through earlier financial crises react and manage better in such situations. Reactions from investors going through the uncertainty for the first time may be extreme. Some investors may completely swear off risk, while others may acquire a trading mentality of entering and exiting the market more frequently in an attempt to protect their gains and time the market. Neither of these are beneficial in the long run. An adviser who can help manage emotions and make decisions to further financial goals is what such investors need to manage the uncertainty better at this stage.