“Life is really simple, but we insist on making it complicated.”– Confucius
The same stands true for personal finance. Humans have two popular ways to pass time – listening and telling stories, and forecasting. There are two laws of forecasting. First Law: For every forecast, there is an equal and opposite forecast. The second law: They both can be wrong.
Timing the market is generally a zero-sum game. Stick to your desired asset allocation. But then, there are times markets move in extremes. You can call this madness of the crowd. Stories get overstretched. During such times, you can trim down your allocation. But then, markets can be irrational for a long time; so you should have the ability to bear some pain.
IQ vs EQ
Investment is a test of your EQ (Emotional Quotient). From 1 Jan 2003 to 1 Jan 2008, Nifty delivered ~43.7% CAGR. During such times, equity seems like Ferrari and fixed income looks like a bullock cart.
From 1 Jan 2008 to 1 Jan 2014, Nifty delivered ~1.6% CAGR and during this period, interest rates were high. In this scenario, fixed income seems like Ferrari and equity seems like a Bullock cart.Equity, gold, real estate and fixed income all have their own cycles. Having a combination of these assets is called asset allocation.Napoleon's definition of a military genius is "The man who can do the average thing when everyone else around him is losing his mind." The same is true for personal finance.
Outsourcing thinking will not help
All advertisements show the advantages of the product. You will not see a pizza advertisement talk about cholesterol. The same is true with investments. Risk and side-effects are invisible and need second-level thinking. A real estate agent will not tell you about the risk of buying an under-constructed property. Or a jeweller will not talk about making charges, impurity, storage cost, or issues of theft for physical jewellery. You will have to think on your own. There is no free lunch in finance; everything has a price. The price for high equity returns is volatility and uncertainty. The price for safe fixed income products is low returns.
Custom fit
Today, in a fast-paced life, we look for ready-made solutions. But in personal finance, everything should be custom-made. Your goals are unique. Your behaviour is unique. When you boil water, it becomes hot. But after some time, it comes back to its normal temperature. The same is true with our behaviour. We get emotional watching movies, inspirational videos, tweets, blogs, books, etc. But then revert to our original self. Our genes, upbringing, friends, parents, society, and circumstances shape our behaviour. Our behaviour is like a fingerprint – it’s unique. Hence, we need to build a portfolio based on our behaviour.
It's a mind game
When you get a promotion, you feel happy. Some chemicals produced in the brain make you happy. You can feel happy even without promotion if somehow your brain can produce the chemical. Exercise produces happy hormones. Gambling produces a chemical dopamine, which is like drugs. That is why gambling is addictive. It all boils down to building a portfolio with the right mix of assets. If you are checking your portfolio frequently, it means you have got your allocation wrong. Either you need to add equity or trim it down.
Keep it light
If many applications are working at the same time on your laptop, do you think your laptop will be able to work efficiently? Close unnecessary windows. Rather than tracking stocks or bonds on a daily basis, invest in an equity and debt mutual fund. Ask yourself, is finding stock ideas your competitive edge? Invest in a combination of actively managed and passive mutual funds to take exposure to the market.
Everything seems simple when you know the ending
Many investors regret not buying March 2020 fall. Today Sensex is at ~50,000 levels and you know the ending now. What if the ending were Sensex at 20,000 level? Would you have felt the same? Every fall looks like a buying opportunity in hindsight. But we freeze when the market falls. And that’s why asset allocation is important. In 2008, the 150-year-old investment bank Lehman Brothers collapsed. One of the biggest insurance companies, AIG, came down to its knees. And on top of it, imagine you losing your job at the same time. Does this look like an investment opportunity?
Importance of right tools
Personal finance has got nothing to do with the noise we listen to daily. The irony is that we consume information that has a few days of expiry and take long-term decisions. We use a microscope instead of a telescope to make financial decisions. When you play the long game, you are thinking of the whole voyage and not what happens next quarter.The truth is that we do not know what is going to happen tomorrow. Markets are crazy and nothing is guaranteed. A market correction is not a bug that can be fixed. It is a feature. Markets have always been volatile and will continue to remain volatile.
Stick to basics
Do not look for efficiency; look for effectiveness. There is no best fund, no ideal asset allocation formula and there is no single indicator that can help you time the market. There are sure shot stocks that are guaranteed to do well. There is also no guarantee that Indian equities will generate the same kind of returns which it has given in the past. There is no guarantee your health will be fine tomorrow. There are so many moving parts and all are fluctuating.
Planning is a continuous process. Your goal post keeps moving. Your risk appetite keeps changing because your circumstances are changing. Build a plan and stick to that plan. Seems simple, doesn't it? But then investors should also keep in mind Mike Tyson's famous quote: “Everyone has a plan until they get punched in the mouth”. They would do well to see that the plan should have a sufficient margin of safety to deal with situations that are beyond their control.
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