M is for Money: Notes from a thirty-something DIY investor
It was a revelation to us that we didn’t necessarily have to sprint with high-risk, high-yielding funds, nor did we have to settle for low-risk, low-yielding bonds. There was a whole spectrum of investment choices that we could tune into, based on our risk tolerance and our financial goals. The trick lay in balancing the two factors to create a robust investment strategy.
For the average Indian born and raised in an average middle-class family, saving money is an exercise in caution, limited to tried-and-tested investment products such as fixed deposits, provident funds, gold, and LIC policies. When the well overflows, the excess is skimmed and stowed for the long haul in local real estate. This is what our parents did before us and this is the path that my husband and I set out to follow immediately after our wedding in 2008.
Five years and one pre-closed home loan later, we realised that the strategy we had picked was setting us up for failure - inflation would far outpace our modest portfolio by the time we reached retirement. Nearly a decade had passed since we joined the workforce and we did not have much to show for it. We were closing in on our thirties and light years away from the possibility of enjoying a comfortable lifestyle post-retirement. A mild sense of panic began to set in at the back of our minds.
It was around this time that my partner opted to attend a day-long session at work on financial statements, conducted by an expert in the field. Having zero background in finance, the training opened his eyes to the underlying factors in the movement of stock price. After some more reading and research, it became apparent to us that the stock market was not exactly the gambler’s domain we had always perceived it to be. Investing in mutual funds was not the same as buying a lottery ticket or rolling a die. There was a method to the madness and that method turned out to be the answer to our predicament.
The Balancing Act
It was a revelation to us that we didn’t necessarily have to sprint with high-risk, high-yielding funds, nor did we have to settle for low-risk, low-yielding bonds. There was a whole spectrum of investment choices that we could tune into, based on our risk tolerance and our financial goals. The trick lay in balancing the two factors to create a robust investment strategy. Since we were both new to this and considerably late in the game, we decided to hire a financial advisor to help us chart our course. It seemed expensive at the time, but it was a valuable learning experience.
The first thing the advisor had us do was write down our short, mid, and long - term financial goals. There had to be a plan for everything - right from gadget upgrades and vacations to family expansion and retirement. This was an entirely fresh perspective on money, and I must admit, a tough one for me to wrap my head around. I have never been one to plan extensively or fuss over details. For me, all our money fell into one bucket - savings. What difference did it make how we used it, as long as we were being judicious?
A monumental difference ostensibly, because these details could directly impact the quality and performance of our portfolio. We learned that money set aside for long-term goals - kids’ education, retirement - would yield greater returns in the relatively volatile equity market. Savings towards short to mid-term goals - a new vehicle, home renovation, a vacation abroad - would fare better in the relatively stable debt market. To put it simply, it was a balancing act of understanding how the market works and exactly what we want out of it.
Although not perfect, we managed to get a few workable goals in place to begin with. Then we moved on to answering questionnaires that would assess our risk profiles. The scores revealed that we were both moderate risk-takers, but we were surprised to learn that my partner’s appetite for risk was a shade higher than mine. We found this both funny and ironic because our personalities are just the opposite. He steers towards security and I tend to be more impulsive. Having endlessly pulled his leg for being boring and unpredictable, I was now obliged to eat my own words.
Learning and Unlearning
With all the data in place, the advisor drew up a comprehensive plan including a list of funds for each of us to invest in. This was based on our individual risk profiles, time frames we had set for our goals, and the current vs. future value of each goal (for instance, a vacation that costs two lakhs today, might cost more five years later). Our future earning potential, including a possible maternity break for me, were factored in as well. My partner was prescribed a mix of equity and debt funds, while I was advised to invest in hybrid or balanced funds. Simultaneously, we were required to undo some of our old investments, especially in insurance.
Our first endowment policies were never purchased keeping returns or risk cover in mind. For my partner, it was a matter of helping out a distant relative who doubled as an insurance agent. For me, it was done to appease my landlord at the time, who sold policies as a post-retirement activity. I was fresh out of college and returning from my first day at work when he accosted me on the stairway. He followed me into our living room, requested a cup of tea and continued to educate me about his “lucky hand” until I finally agreed to sign up for a policy.
A decade later we were still paying yearly premiums, but we realised that the returns from these policies were going to be abysmal, and they did not even provide adequate risk cover to make up for the loss of income. It would be wise to shut them down and opt for term insurance instead, which would give us higher coverage at economical premium rates. The caveat, however, was that there would be no returns at the end of the term. Once again, my partner was quick to jump on board with this but I couldn’t wrap my head around it - the probability of something untoward happening was low, and it seemed like we would be throwing away our money on a baseless fear.
We had several conversations around this before I finally understood why term insurance is important. Vishal Khandelwal, investor and founder of Safal Niveshak, describes it perfectly, “... term insurance is a “cash flow” insurance – it ensures the cash flows your family would need to survive, whether you are alive or not.” It wasn’t about the person or the probability, it was only about protecting our monthly cash flow. It wasn’t about money spent but the assurance that our dependants could live comfortably without forgoing their aspirations or quality of life in the event of an untimely demise and loss of income.
Transitioning to DIY Investing
A year since we had started the process of our financial makeover, our portfolio had completely changed. Instead of low-yielding fixed deposits and endowment policies, we were now investing approximately 50 percent of our savings in equity funds, 40 percent in debt funds (ultra short-term, medium-term credit risk, and government bonds), and the rest in our PPF and NPS accounts.
In this time, my partner’s interest in personal finance had deepened considerably. Having read several books, blogs, and opinion pieces by expert investors, he began to develop his own investment philosophy shaped by the likes of Avinash Luthria, Howard Marks, Parag Parikh, Monika Halan, and a few other Indian fund managers. His ideas deviated in some ways from the funds suggested by the advisor. When the time came to renew our yearly contract, the advisor had switched his compensation structure from a fixed fee to a fee as a percentage of assets under advice.
Having started our accumulation phase late, we decided this wouldn’t work for us. We also looked into other online robo advisors that appeared to be fee-only, but they did have hidden trail commissions and were suggesting regular funds that have high expense ratios (as opposed to direct funds that have lower expense ratios because they skip distributor charges). At this point, it made sense to move on to self-directed or DIY investing, where we would be building and managing our own investment portfolio.
Don’t Try This At Home!
In the four years since we made the switch, my partner’s focus has been to minimise investment costs through index funds - a type of passive instrument designed to “mimic the composition and performance of a financial market index” (such as the Nifty 50), with no fund manager to actively select stocks. In The Little Book of Common Sense Investing, American investor John C. Bogle wrote: “Index funds eliminate the risks of individual stocks, market sectors, and manager selection. Only stock market risk remains.” He went on to add, “... when you understand how our financial markets actually work, you will see that the index fund is indeed the only investment that guarantees you will capture your fair share of the returns that business earns.”
Following the old stock strategy of buy low, sell high, we also set aside some money for lump-sum investments during market downturns. My partner has devised a rule of thumb where the amount invested matches the fall in the market. For example, a ten percent fall from the market peak will elicit an investment of ten percent of the surplus, and so on. Of course, this is easier said than done because of the psychological barrier - the instinct of fight or flight. When faced with a dip in the overall corpus, our foremost instinct is to dump everything and run, before we end up losing more. It takes conviction to be able to pump money into a bear market.
In retrospect, I understand that our risk profiles did accurately mirror our individual personalities. I am more emotional, hence impulsive; my partner is more logical, hence deliberate. A logical person would be better suited to taking calculated risks, while an emotional person may let fear dictate her choices. Emotions and investments, when mixed, spell out a recipe for disaster, which is why I think DIY investing may not be the way to go for everybody. My role in our financial profile is passive. I understand what we do and why, and I make sure to ask questions before any major decision, but I would not be interested in building an investment portfolio on my own. Without my partner, I would definitely seek the help of a financial expert.
Back to the Basics
Nevertheless, our journey of the past five years has taught me enough to understand the ABCs of investments. I believe these are the essentials that belong in the toolkit of any successful investor:
Goals: Goal-based investing can help you navigate, stay focused, and prioritise. The act of writing down your goals helps you financially and also gives you perspective on what’s important to you in life. My partner and I realised that owning a home is not something that either of us wants, so we do not plan to take a second home loan. Setting goals enables you to get real about your aspirations, both immediate and long-term. Since aspirations do change, it’s also important to keep revisiting and refining your goals every year.
Financial Planning: Next, look at how much money is needed to achieve each goal, how much you have already saved, and how much you need to start investing. Consider the time frames and future value of your goals, and set reasonable return expectations. Thankfully, there are plenty of free automated calculators available online to help chart your financial plan. You then need to pick the instruments that you will invest in, based on your risk tolerance. A financial advisor or a robo advisor could help you get started here.
Emergency Funds: Plans represent the best course of action, but there is always the possibility of unforeseen events setting us off-course. In such scenarios, an emergency fund can be a lifesaver. The amount you set aside will depend on the stage of life you are at - single, married with/without kids, and the number of dependents you provide for. Usually, an emergency fund can consist of anywhere between six to twelve months of your monthly expenses, including EMI payments if any. This amount could be invested in low-risk fixed deposits or ultra-short term liquid debt funds.
Insurance: Again, this depends on the stage of life you are at. You need not consider buying life insurance on your name if 1) you hold enough wealth to support your dependants after your death, 2) you are not the major breadwinner of your family, 3) you do not have any dependents at present. However, do keep in mind that the cost of insurance goes up as you age. The same is the case with medical insurance, and it is prudent not to depend solely on the medical cover provided by your employer. In our case, my partner met with an accident and broke his arm when he was switching jobs. Our second medical policy bailed us out of what would otherwise have been a huge hospital bill.
Patience: Building wealth is a game of discipline and patience rather than passionately chasing returns. In their book, You Can Be Rich Too, PV Subramanyam and M Pattabiraman make it clear that “Returns are not the sole deciding factor of how much money you are going to make from your investments.” The two other factors, they say, are the amount you invest and the amount of time your money stays invested. Of the two, they prove that the impact of time is the greatest. Once you have chosen which baskets to place your eggs in, you stay put and resist the temptation to move them around every time you come across a new or higher-yielding instrument. In the words of the legendary Warren Buffett, “Someone’s sitting in the shade today because someone planted a tree a long time ago.”