2011 has come and gone and investors might be sitting back and contemplating on how their investments have done. The 2011 year has been a great teacher of sorts to me. I learned the basic tenets or basic rules of financial planning (again) which I want to share with everyone. We often get carried away and forget these tenets but it is time which does it’s own trick and brings this to our attention.
2 Basic Rules of Financial Planning – Let me explain myself.
The first lesson
When 2011 started, like everyone, I wanted my money to grow and the only way to look at was equity investing. Direct stocks aren’t my cup of tea so the only route I was looking at was systematic investment planning of mutual funds.
After some months of investing it hit me hard that the stock markets cannot be your saviour all the time. The Sensex was going down with each passing month and I had a premonition about what December could hold. In a year where the Sensex lost 25%, my only investment vehicle for making money let me down.
Or did it? Gosh, no it didn’t. I follow goal based investing approach and none of my goals were impacted by the negative growth of the Sensex in 2011. So why fret ? I told myself – long term investing is what I believed in and this was an opportunity for me to buy more number of mutual fund units at a low price. In that same breath, I prayed for a flat stock market in 2012.
I recollected that 2008 was similar. Everyone was running away from the stock market and no one heeded what Warren Buffet once said – “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
I had headed the advice in 2008 and I just needed to head it in 2011.
So the first lesson I re-learnt here is :
There will be troubles and volatility in the short term; it will unnerve you and make you take wild and weird decisions, like selling off the mutual fund portfolio as it is causing losses, but this is the time to lie low and keep investing. Take the noise out of your ears; plug in basic financial planning concepts in your mind and you are on your way to making riches.
It is time in the market that matters.
Basic Rules of Financial Planning – The second lesson
I had some money parked in FDs at the beginning of the year. The rate on them was around 8% average. By the time the year ended, the rates were around 10% average. So I would have lost out on 2% if I were to lock in a huge amount of money at the beginning of the year.
Somewhere along the first quarter, I began investing in short term debt mutual funds. The strategy had to pay off given the interest rates and its consistent rise. At the same time, I was investing systematically in gold funds. Gold has returned around 32% in 2011. While some products in my portfolio performed badly, others did well. Overall, my portfolio was bruised but not battered.
And therein lies a key basic tenet of financial planning which helped me sustain the negative impact on my portfolio. Thanks to this wonderful word called DIVERSIFICATION.
In a year where the stock market fell badly, my investments in gold and debt mutual funds paid off. The overall impact equities could have caused to my portfolio was significantly reduced because of my investments in diverse products.
This is the most basic rule anyone will teach you in personal finance – not to put all your eggs in the same basket.
In a year where debt and gold were saviours and equities a big let down, if you had strategically and actively diversified your portfolio, you might have seen less losses.
But this is what most investors do not do. The knee jerk reaction that most investors make is to pull their money out of equities. And then stop investing in them. They will then park that in cash elsewhere or do FDs as 10% is still an attractive rate of return. The concept of short term and long term debt mutual funds is not very often used by everyone. Although it is quite easy to understand and implement.
Faced with these challenges, many investors would have let the 2020 opportunity of investing money in equities and using diversification to their advantage go by.
And the second lesson in basic rules of financial planning I revisited in 2011 is simple as well –
Do not put all your eggs in the same basket. Diversify across different asset classes.
In times of volatility, some active management of your money is required. Your basic asset allocation will drive how much money you need to spread across different investment classes.
What did you learn from these basic rules of financial planning dear readers ?
Radhey,
Good one, thanks for sharing your personal experience.
As for me it was patience in investing in stock markets. 2011 had a big knock on my portfolio. Many times i thought of taking out some money and investing in FDs @ 10% or NCD’s @ 12% which were quite tempting. But then since my investment horizon was long decided to have faith in the market rather Indian economy.
As for FD’s i switched couple of them that were giving me 8.5% returns to NCD’s @ 12%. I did pay penalty of 1% though but then with inflation at 9% i was not making any money.
Agreed NCD’s are risky but we need to take risk to earn money.
Stock market is also a risky business.
Rakesh
@Rakesh, Patience is another learning no doubt. I also twitched to withdraw my money but resisted like you in the end.
Want to do an article on NCDs in th future, thanks for bringing is to my attention.
Radhey,
Yes, an article on NCD’s would be good. Since last 6 months we have seen several NCD’s come out and which have stable rating from Crisil too.
But never know how risky would that be.
The current issue of Muththoot finance NCD is offering 13@ for 2 years.
Rakesh
@Rakesh, Did you invest in them ? How much do you think should a person’s portfolio be in NCD in % terms ?
Radhey,
Yes i did invest in the current NCD’s of Muththoot finance for 2 years only. I think a person should invest between 5-10% only in NCD’s. Earlier issues of all NCD’s had minimum 5 years. Looking at the balance sheet, the debts that the company has it was risky. Even Crisil gave a stable rating.
I was thinking of investing in additional FD’s but then this issue came out. I don’t think the company will close down in two years.
Rakesh
@Rakesh, For your sake, let’s hope so 🙂
Quite some lessons which other can learn.
@Sudip D, What did you learn Sudip ? Or nothing in 2011 for now ?
@Radhey Sharma, Well I personally didn’t invest in 2011 but yes, have become aware of the many aspects of money market a lot in 2011.
I guess 2012 is the year for me to kick off.
P.S. Thanks to you (& couple of other readers here) for becoming one of my source to keep myself abreast with the many facets of finances. 🙂
Hi,
I too have continued my SIPs inspite of market downturn. Reagrding second point, Diversification works when a person know when to exit certain class of investment. I doubt whether all the class of assess will give net positive returns.
@Venkat, Why do you say so about diversification, that it works best when one knows when to exit certain classes of investment ?
@Radhey Sharma, What I meant is if we have everything in portfolio then we may have adjust weightage according to market condition actively. Please correct me if i am wrong.
@Venkat, In a way you are right. When you stick to a defined asset allocation for yourself, you sell buy products to come back to that allocation.
So support your allocation says you need to have 60% in equity and when the stock market rises, your allocation probably will go to 65%. You would want to sell 5% to come back to 60%. This also forces you to make profits.
@Radhey Sharma, I’m not very sure on how frequently we should try to re-balance our portfolio. By it’s nature, the non-fixed investment avenues fluctuate on a daily basis and re-calibrating our portfolio to match our “ideal” portfolio would be a cumbersome, time-consuming and hassling activity.
I have heard and read that we should not bother about daily movements but rather gaze over our portfolios monthly or quarterly basis – but then if the equity segment makes a big movement suddenly, our balanced portfolio goes for a toss. At times I feel waiting for the “scheduled” time for re-balancing the portfolio isn’t the best thing to do in such case. What should be our approach in such times?
For re-balance of portfolio, i can share my experience on MF.
I usually monitor the MF performance for 2-3 quarter and compare it with it peers. And still if it under performs then i switch to other good MF.
Rakesh
@Rakesh, That’s what my understanding was, until I learned that there can be valid reasons which may result in a reasonably good fund under-perform it’s not-so-good peers for a couple of periods. Such reasons can include a spike (possibly “managed”) in underlying stock(s) held by the not-so-good peer. I was naive to believe that only cricket matches could be “fixed” 😉
@Rakesh, Obviously, I think you would move to other funds not only based on the recent performance of this fund, but also on the long and short term performance of the new fund you are moving in.
@Rakesh, I like the strategy. No harm in this I guess.
@Jaswinder Singh, Balance twice a year if you have the time for it. Also balance when MAJOR events happen in the economy/stock market and your portfolio goes through wild swings.
Does not make sense to do it each month.
@Radhey Sharma, Instead of buying a separate equity fund and debt fund and trying to re-balance as the market rises, why don’t we get a balanced mutual fund itself according to the asset allocation we prefer?
@Manickkam, There are 2 schools of thought here. One says, keep equity and debt separate; the other says, mix them via balanced funds and invest.
One can do any. Remember that the balanced fund will not follow YOUR asset allocation but its own which need not be similar to the one you have.
There is always news for market to go up and market to go down. Only after it happens, the real detailed analysis will be done and all would say it happened because of this.
No one can even predict what would happen any year in the stock market.
Instead of timing the market, its best to remain always invested in the market if you are a long term investor.
These are some of the things that I learnt in 2011 from the stock market side.
These two lessons are the 101 of investing. There are two very strong assumptions in your first learning/advice
1) You are assuming that the underlying long term (5-10 yrs) trend of growth will continue. What if we are entering a game changing period where there will not be any growth for next 20 yrs?
2) The second assumption is that people have deep pockets and they will continue investing in downturn. Most of us can do that only upto a point of time. After that obligations/liabilities will force you to bail out.
Pawan,
First point is very scary, no growth for 20 years. That will test too much of people’s patience and they will look for new ventures of investing.
A good example is when FII’s found Indian market attractive they started pumping a lot of money and when they saw it non-performing(scams) they are slowly taking out the money and investing in other countries.
Agree on the second point. But then we have LIC which can invest in our markets and bail it out.
Rakesh
@Rakesh, Basic understanding is market tend to be erratic in short term and give good returns in long or very long term
But, if the first scenario happens (no growth for 20 years), almost all fields see no increase and markets standstill or have a downfall along with it. New avenues will also give very less returns and only a revival happening will be marked in history along with its new.
@Pawan Nanda,
Hmmm. Financial planning is all based on estimates and assumptions for the future.
If we have to make money and meet all our goals and for that, the investment classes have to grow over a period of time.
If they don’t, I would call it a catastrophic event, akin to World War III.
Having said that, I don’t believe that the market will not grow for 20 years. At least in India, we are yet to see the last and final phase of massive growth which every growing economy goes through.
Now if we are entering a phase of no growth, we will still have some insruments which will save the day for us though they might not return as much as equity. Maybe we can use that.
The second assumption you mention is right. One should have parked some money in debt (which can be easily made liquid quickly, eg debt mutual funds), which should be used to rea-lign asset allocation. But you will do that to a limit.
@Radhey Sharma,
20 was just an illustrative number. Most of us will not survive a 5-10 yr no growth period. Regarding the possibility of that happening, it’s not as remote as we think. In the past also, there have periods when clocked > 7% growth for a couple of years and then fizzled out for next 10 yrs. I believe that happened around 70s.
Now also, I don’t see us fixing our basic building blocks – education, healthcare, infrastructure, process to ease doing business in India. Compared to 10 yrs ago, we are more corrupt, public healthcare and education is worse and doing business is tougher. The only thing in our favour is demographics. Fortunately for us, other countries have a huge problem of aging population. But it’s very easy for us to squander this advantage if we don’t fix the basic problems.
@Pawan Nanda, Pawan, I have been going through your posts with interest and though I have not yet considered a longish no-growth period, but I am inclining towards considering this in my long term plans. Thanks for bringing this up!
@Pawan Nanda, Hmmm. Honestly, I’d have to come to terms the hard way to the fact that we are not going to get any growth for so long, if at all that happens.
I don’t believe many people know where the economy will go for sure – it’s like predicting when the monsoons are going to come or where the stock markets are headed.
Regarding India’s ability to deal with the slowdown, I ‘d agree with you on the fact that we are just losing an opportunity to do what China seems to be doing better. They call it Policy Paralysis in the dailies 🙂
Hey everybody, I happen to read this post “3 Important Investment Lessons from 2011” in Yahoo the other day & I thought of sharing it with you all (also because it is quite related to this blog post).
Here’s the link – http://in.finance.yahoo.com/blogs/ymoney/3-important-investment-lessons-2011-070445423.html
Read it & let me know your thoughts. 🙂
Hi
How frequent should one analyse his funds?
How and When should you come out of a non performing fund?
How it should be reinvested?
Appreciate your valuable thoughts on these.
Regards
@Shinu, Probably 3 topics of articles I can write on. Watch the space.
@Shinu, You can get some pointers in the comments for this article itself. I had asked a similar query as your query # 1 (refer #comment-9100) and some responses might interest you as well.
My strategy last year was similar to yours.Asset allocation and diversification are very important.
@Radhey, I think you should republish this article every now and then to remind the readers about these two important tenets. Most of us tend to repeat these mistakes over and over again so it is important to be reminded.
I have learned these lessons the hard way but enjoy learning them again in softer ways.
@Vivek K, Yeah that is the point – read and re-read basics – it will keep one away from the noise !