Let’s do a little word-picture association. I’m going to write a term. You have to make a mental picture.
Did you just picture a corporate suit? Scrutinizing all kinds of numbers and charts? Poring over spreadsheets and piles of documents on the desk in front? Maybe with a magnifying glass in hand (No? Maybe that bit was just me)?
Most people I asked pictured something similar, and I couldn’t help but wonder why. Why do we picture a person/setting so distant, so unfamiliar? Do they exist in a different world, with no relevance to our everyday lives? Why, in fact, do we only think of a professional? Don’t we, as individuals, manage our own finances?
Whether it’s as simple as balancing our check books, setting aside some savings in a bank account, or even deciding which stocks to invest in, we make daily decisions about how we spend, save and invest our hard earned money. We are managers of our own personal fund.
Professional fund managers grapple with similar decisions on a larger scale. But can we find some essential principles that underlie their approach, principles that perhaps we can apply to managing our own money?
7. PATIENCE IS A VIRTUE
You’ve definitely heard the phrase ‘Time is money’. It’s so clichéd, in fact, that I remember it was quoted in ‘Kyunki Saas Bhi Kabhi Bahu Thi’ once (what was I doing with my life?).
But as with a lot of clichés, there’s a basic truth behind it. A fund manager knows it will take time for an investment to generate returns. Not only that, but the longer the investment is held, the more returns it can generate, due to the effect of compounding. Sometimes, short-term volatility is the price for long-term growth. Professional managers know this, and use it to their advantage.
The lesson? Wherever you choose to invest your money, be patient. It may be a while before you see growth. Nothing will grow your money overnight.
6. INFLATED ECONOMY, DEFLATED RETURNS
Fund managers know to *judge investments by the inflation-adjusted, and not the absolute, returns *that they generate.
To take an example, the rate of return for Fixed Deposits is around 8% right now. Adjusting for taxes, the effective rate of return can be 5.6% – 7.2%, depending on your tax slab. Inflation has been around 7.5% on average for the last 5 years. So if you’re investing your money in an FD, it’s potentially losing its value!
5. MAINTAIN LIQUIDITY
Since they handle money from a large number of sources, any of which can submit a redemption request on short notice, fund managers must earmark a pool of funds from where such requests can be fulfilled. In other words, they know to maintain a certain level of liquidity to address short-term needs.
In exactly the same way, you also need to maintain a certain level of liquidity to take care of short-term, unplanned or emergency expenses. It could be because of a medical emergency, an unforeseen car repair, or an impromptu poker night.
4. DIVERSIFY YOUR INVESTMENTS
To use another clichéd phrase, ‘Don’t put all your eggs in one basket.’ Professionals know the importance of diversification when deciding which assets to invest in. Asset allocation is a fundamental component of their investment strategy.
The same should be true for you. Sure, you can choose to put all your money in ‘safe’ investments, like FDs, or a PF, or (heaven-forbid) money-back insurance policies, if you want to minimize risk. Or you can invest your life savings in that one hot stock that you heard about on TV. Either way, you’re bound to be disappointed sooner or later. You may end up dissatisfied with the ‘safe’ returns 10 years from today, or recoil in horror as the hot stock nosedives.
When looking at the performance of an individual investment, fund managers always keep in mind where it fits into their overall plan. They don’t get carried away with the performance of a single asset, whether it’s scaling new heights, or making a dive. They will compare reality with their expectations, and make a well-thought out decision about whether to execute differently.
Your net worth comprises of all the financial assets you own. It includes your income stream (whether salary, business, rental or interest income), savings/FDs with your bank, money-back insurance policies, real estate, investments in stocks/mutual funds etc.
You chose to invest your money in different things for different reasons. Your worry about each individual item should be proportional to why you chose it, and how much of your net worth it represents. Don’t let short-term fluctuations influence long-term outlook.
Rebalancing is an investment principle that is not known or followed widely. It entails reviewing your investments periodically to determine if your current exposure to different assets matches your desired allocation.
Didn’t get it? It took me a few tries as well. Let me illustrate with an example.
You have Rs. 100 to invest. Based on your risk profile, you decide to invest Rs. 50 in an equity mutual fund, and Rs. 50 in a debt mutual fund (50:50 equity:debt ratio). After a year, the debt fund has grown by 10% (to Rs. 55), and the equity fund by 30% (to Rs. 65). The equity:debt ratio is now 65:55 – no longer equal. So you redeem Rs. 5 from equity, and invest it in debt, and your asset allocation is back to parity i.e. 60:60.
Rebalancing is also automatically tuned to make you buy low and sell high. As in the above example, you sold equity when it outgrew the rest of your portfolio. Conversely, you would purchase more equity if it under-performs compared to other assets. Fund managers know this, and make it an integral part of their strategy.
The above was an example of rebalancing done at an overall level. An even better way to rebalance is according to your goals where each goal gets its own asset allocation and gets rebalanced accordingly. You can read more about Goal based investing here.
1. PLAN (AND STICK TO IT)
Investment funds have dedicated teams whose sole job it is to perform research on their current investments, and seek new investment opportunities that can help them achieve their goals. They sort through data on each asset from multiple sources, and convert it into actionable information. Based on this research, fund managers formulate an investment plan, and decide when to buy/sell a particular asset. They change their plan only if some new and substantial information leads them in a different direction.
As an individual, you should understand your finances, figure out your goals, and allocate savings in a way that maximizes your chances of reaching those goals. There is a lot of good information available on the internet about various financial products, and you must strive to gain at least a basic understanding of any instrument you consider investing in.
*Once you come up with a plan, follow it diligently. *Don’t let short-term gains/losses make you change your course.
Don’t just ride the wave. Sometimes, you have to brave the tide.
You must strive to be the best fund manager you can be. After all, this is your own hard earned money that’s at stake, and it’s up to you to maximize its potential!