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Cool heads and high returns

All equity crashes set the foundations of high returns for those who refuse to panic.

Cool heads and high returns

In late March, the general idea among investors around the world was that there will be a severe global recession and a stock-market crash of unprecedented proportions. Much to everyone's collective surprise, one half of that prediction has been belied so far. There was a crash, but some smart recovery too. Might the other half also prove to be false? Or could it be that both parts might yet come true?

We won't tell you that we know the answer because at this point, no one does. However, it's pretty clear that businesses and economies around the world are in for a particularly bad time. People will suffer, businesses will go under and governments' efforts will light the flames of future fiscal problems. No country will escape this.

However, what we definitely will tell you is that you, as an individual saver and investor, can come out of this crisis with your portfolio not just intact but stronger. There will be uncertain times ahead, but there need not be any great disaster if you keep a cool head.

What you must (not) do
Investors around the world are asking what they should do. The answer is that they should do almost nothing.

This is true from the biggest to the smallest investor in the world. Warren Buffett's and Charlie Munger's diaries are blank, just like they should be for everyone. In an interview with the Wall Street Journal, the 96-year-old Munger revealed recently that Berkshire Hathaway is not looking at any investments right now. Despite having one of the largest holdings of cash in the world (about US$ 125 billion, or about Rs 10 lakh crore) and assets going cheap, Buffett and Munger are sitting on their hands. Munger makes it clear that this is not a situation that he understands (or anyone understands) and therefore would like to ride it out with all their liquidity intact rather than rush into something and regret it later. As he says, "This thing is different. Everybody talks as if they know what's going to happen, and nobody knows what's going to happen." According to Charlie Munger, this is not the time to do anything at all, except to stay exactly where you are. The best course is to not change course at all.

Despite having less (a lot less!) money than old Charlie, we fully concur with him. Since the beginning of the COVID phase, there are investors who want to redeem their funds and run away whenever the market crashes, as well as when it recovers. Times like these, when markets are making big moves up and down, are just the kind when investors are most tempted to try and do some timing. It looks like such an opportunity missed. You could have sold when the first news of COVID came, and then bought when the first sharp fall was done, and then sold in May, and then bought again around. What a fortune there is to be made by exploiting the sharp and quick ups and downs that equities have been having.

Except there isn't. Timing does not work. There is no way to make money from stocks in a sustained way except to choose good businesses and invest in them for a long time. In the months to come, a lot of business will do badly, but the good ones will do better. First, they will do less badly, and then the tide will turn. This is inevitable.

A foggy landscape
Seek and ye shall find. While there is no dearth of negative news today, there is reason to be hopeful too. The IMF says that India could be one of the major economies to witness some GDP growth - 1.9 per cent - later in the year. Of course, the IMF is probably just guessing as blindly as everyone else but this is in contrast to other advanced economies which are estimated to contract.

The government hasn't exhausted its salvos to combat the effects of the pandemic either. In a media statement, the finance minister said, "I have to be ready (going ahead)... because no one knows how this lockdown is going to turn out, how this is going to end, how this is going to withdraw. So obviously I have to be ready. I can't finish my story with these announcements."

Those who like to see the glass half full are pointing at the new trends that will gather pace. For instance, the use of technology has got a boost amid the lockdown. This has the potential to transform the way we work and connect. Over time, it is likely to result in lower operating costs and higher efficiency.

The shifting of production from China to India is another theme. The single-sourcing of a large chunk of the world's industrial output has been highlighted sharply. It's inevitable that countries will seek to lower dependence on China, especially given that country's new-found belligerence in foreign affairs. India is well placed to benefit at least partially from this.

Additionally, normal monsoons, as forecasted by the India Meteorological Department, will also help douse the fire ignited by the pandemic. As recent economic data have shown clearly, the rural economy is largely unaffected by the lockdowns. Hence, the monsoon will definitely help.

Unleash the financial warrior in you
All things said, the pandemic and the lockdown have had an enormous impact on investors. They had to not only deal with unreasonable market movements but also worry about a loss of income. However, difficult times create strong investors. While no one still knows the extent of the damage caused by the pandemic or when a permanent solution will be available, what we do know is how to prepare ourselves. It's all about getting back to the good, old wisdom. Here's a list of your personal SOPs.

Build a sufficient emergency corpus:
Emergencies come unannounced and can take a toll on your overall financial plan and savings. Hence, it is essential to build a sufficiently large emergency corpus before you start investing. There is no fixed rule for how much you should keep aside for emergencies. Normally, your emergency corpus should be sufficient to take care of your expenses for six months. However, given the current scenario and the prevailing uncertainty, maintaining an emergency corpus to take care of your one-year expenses isn't a bad idea. You can keep part of it in your savings bank account for easy accessibility and the rest in good liquid funds.

Get adequate health and life insurance:
The uncertainties of the last three months have only highlighted the role of health and life insurance in your financial plan. A health cover for you and your family goes a long way in protecting your savings in the case of a disease. If you have financial dependents, you must buy a life-insurance cover in your name to safeguard their future in your absence.

Stay disciplined:
The recent months have disciplined us in many ways, including with respect to our spending habits. It's even more crucial to stay on track now. This is especially needed for those of us who otherwise find it difficult to save at all. Stay away from unnecessary borrowings. Avoid credit-card overdues at all times.

Mind your asset allocation:
'Asset allocation' seems to be a fancy or a complex thing. But it's very simple in spirit. It is about dividing your money between equity and debt. Rather than trying to figure out the ideal equity-debt split for you, simply invest according to the time horizon and your asset allocation will take shape on its own. You can break down all your financial goals across the following three time-spans and plan as described.

I. Near-term goals: Safety first
These comprise your goals that are due within the next three years. For this set of goals, safety of your corpus and its liquidity are utmost important. Returns are only a secondary consideration here. For these goals, you can invest in top-quality liquid, overnight and short-duration funds. There are as many as 16 types of debt funds available but you can do with just these three categories.

A series of downgrades and defaults in debt-fund portfolios have shown that even debt funds aren't free from risk. Hence, it's important that you pay attention to your fund selection. Don't be lured by performance or past returns. Instead, focus on the quality of the portfolio. To generate mouth-watering returns, debt funds assume credit risk but that can backfire. The recent closure of six of Franklin Templeton's debt schemes was an outcome of the exposure of the schemes to low-quality bonds which turned illiquid.

You can check the underlying portfolio of a debt fund on VRO. If a fund is mostly invested in AAA or A1+ papers, its safety quotient is high. On the other hand, if a major part of the portfolio is invested in instruments rated AA and below, it's probably assuming more risk to increase its returns.

II. Medium-term goals: Tread with caution
Goals that are three to five years away can be termed as medium-term goals. This set of goals is the trickiest because one has to strike the right balance between safety and returns while making an investment choice. The temptation of some extra returns makes many investors go for equity for these goals. But that could turn out to be an expensive mistake. If the market suddenly collapses, as it did recently, you may be left with a diminished corpus at the time you need it. What's more, you won't have much time in hand to allow the market to recoup some of your losses. Hence, don't make the mistake of investing in equity for your medium-term goals, looking at the current subdued levels of the market. We still don't know when the danger of the pandemic will subside. Till then, there will be a lot of uncertainty in the market.

To get a measured dose of equity for your medium-term goals, you can go for equity savings funds. These funds invest about a third of their corpus in equity, about a third in arbitrage and the remaining in debt. Due to their equity and arbitrage positions which are at least 65 per cent, they are treated like equity funds from a taxation perspective. You get steady returns from the arbitrage and debt allocations, while the equity allocation helps you boost your overall returns.

III. Long-term goals: Equity without fear
Goals that are over five years away are your long-term goals. For such goals, go for equity. As an asset class, equity helps you beat inflation over the long run. It also helps you compound your wealth and hence accumulate the required corpus.

The current low levels of the market provide an opportunity to boost your long-term returns. While it's true that the current business and economic environment is full of uncertainty, history suggests that over the long term, not only does the economy recover but it also resumes its upward march. Hence, for equity investors, it pays to be optimistic. Humankind has endured severe recessions and occasional depressions but they haven't been able to stop its progress.

Instead of directly getting into stock-picking, taking the mutual fund route will especially help in these times. As always, invest through SIPs. Don't make the mistake of investing large sums, thinking that the market has hit a bottom. Don't hurry either, looking at a sharp market recovery. Equity investing is more about patience than timing. Through SIPs, you can average your investment cost, without worrying about the market levels.

The best equity funds to invest are, as always, the multi-cap ones. Because they can invest across companies of all sizes, they are best placed to leverage the opportunities available. You can visit www.valueresearchonline.com to find the best multi-cap funds. Pick three-four and get going.

That's all there is to it. Hopefully. But then, in uncertain times like this, we'll certainly be here every month to talk about where we've been and where we must go