Decide the LESSON you want to learn: applying behavioural finance
Few days of extreme volatility, experts are back with a long list of advices. They are all over television to telephone, news paper to New Delhi! Though I stopped reading news paper and watching television for sometime now, something caught me. While these financial wizards (at least they claim so) trying to sooth our nerves I was gathering few common factors pointed out by these gentlemen at the time when balm is required to relieve pain. Here they are:
Risk appetite management: invest according to capacity, diversify your asset class. It goes with rhetoric and irritating comment such as” don’t put ALL your eggs in basket” and this is called as age old wisdom. Does this work for everyone?
In first place what is relationship between risk appetite and diversification? Appetite means desire to eat food, sometimes due to hunger. Risk appetite is tolerance the level of risk an object (organisation or individual) is prepared to accept. I have 300 rupees to invest a. I pay 100 bucks to underworld b. Another 100 to black marketeer c. 100 bucks in gambling (race course/game) . What wonderful diversified assets are, well I am diversified boy.
If you are 20 plus something it’s assumed your risk appetite is higher and if you are 60 plus then you should read holy books and go for pilgrimage after keeping money in fixed deposits. Throw the 40 years of experience in stock market to trash bin!
how do I determine my risk appetite, I need to ask few psychological questions and decide the asset allocation. Now take a question do you have life insurance policy? No man I don’t have one; oh my god are you crazy? How can you survive without an insurance policy? So what I am Warren Buffett or Mukesh Ambani? Still life is risky, I need to insure. Similar concerns for mediclaim insurance without even knowing how many claims are getting rejected? Majority of insurance policies are not valid after 60-65 where you need the most.
you must buy a flat on EMI even if my economic profit is negative. So what, I buy a house at 23, buy the time I retire it requires 50% of cost as maintenance! So what even if the real estate doesn’t go anywhere in last ten years.
Biggest fallacies you can find within risk appetite simply because it’s a complex subject needs customised approach.
- If you know ONE asset class stick to your expertise which will reap benefits. Knowledge is built over the years, so if you are good at equities don’t waste it by diversifying, same goes for real estate. Losses from asset class can be managed through MONEY MANAGEMENT not diversification. Diversification adversely impact return on investment, what bigger joke it can be, to avoid uncertainty you jump into an area where you have no clues!
- Insurance may not be solution for all, if you are 40 year old and have 40 years of net worth days…all you should be concerned developing a plan which ensures your money move faster than inflation. Shut down the damn insurance policy!
- Don’t make house on EMI as emotional decision. Real estate is nothing but an asset class, if it doesn’t offer you adequate returns don’t mind to look for alternatives. For example upmarket properties in Bangalore has fallen into abysmal rental return of 1.5% or even less per annum! Can you imagine your payback period is 70 years?
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Tax benefits: You know you get tax benefits on dividend, or even long term capital gain on shares (actually they are tax free now). Similarly you buy a house , you get tax breaks! Why so much insistence in saving taxes, well I don’t know what the govt is doing with my taxes? Valid question, by paying 70 bucks for a petrol (which includes hefty excise and sales tax) you even don’t know what the govt is doing with your money. If one earn simply pay off taxes, or get ready to fight govt in courts. There is no third solution, use tax benefits like usage of credit cards. If a tax benefit and sale of asset coincides then use it or else ignore!
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Invest over long term: famous dictum, in equity they add word systematically also! So what Bangalore is becoming a concrete jungle with 40% inventory lying empty? So what on 5th of Nov stock market is expected to crash over election results because my systematic plan says 5th? Because in long run asset class performs better, well the man who sold me a stupid insurance policy 15 years back is not working with company any more not even to clarify the word long term. Cyclical trends, secular fluctuations are eternal truth for any market which is based on supply and demand. Learning those curves will help better!
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Average your investment price: one of the biggest fact for loosing money in equity markets. The reason behind a fall may be due to my error in calculation, market risks etc. I must respect demand and supply, evaluate carefully than blindly averaging out. Every 90% fall in price requires 900% to break even!
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Don’t sell in panic: you shouldn’t sell in panic when your goal is long term. BSE in 1979 was 230 and now 27000, really? How many have invested at 230 and 27000? 230 level appeared for 1 second and you know I was a Batman who reacted almost like robot and clicked the button on 230. I am a Dinosaur expected to survive another 350 years , hence I am long term! So what I loose 90% of investment? So what I invested in a rogue company? Set strong rules and kill the position beyond your so called risk appetite. Market is not going anywhere, you will get plenty of opportunity to do well and buy.
- Avoid negative CAGR which is more damaging for wealth creation. Three years 16% positive return followed by 4% return is far better than 3 years with 30% positive return and 1 year negative return of 40%!
- Asset classes are full of uncertainty and remain going stay like than unless government regulate them. It’s only rules and plans will help you to cut out the emotions.
- Your lifestyle decides your net worth not income, manage discretionary expenses out of discretionary income. If your annual spend is 6 lacs, all you need is 40 lacs to make 15% on ROI.
- Don’t block your economic profit perpetually. For those not clear about economic profit here it is. Economic profit is the one you generate after paying for cost of funds. So if I am making 10% return on investment (say capital appreciation on flat per year) against interest rates of 10% then your economic profit is a big ZERO!
Currently I am working with my young cousin who happens to be extra ordinarily brilliant……this 25 year old have 1 twenty years EMI, 2 five years EMI, half a dozen insurance policies apart from tax saving instruments. Don’t forget those sweet little credit cards, I can see a 45 year old now still scratching head with EMI. Habit developed can be changed but not so easily as people think!
Stay safe and have fun!
Turbulence is ahead.