Both driving and investing / savings are integral parts of our lives. Both take an individual from point X to point Y either physically or financially.
In driving, you use the road to travel and reach your physical destination. In investing, you use various investment assets such as equity, gold, debt, real estate, fixed deposit or insurance, use the platform (an analogy to the road) to achieve your financial goals in a timely and safe manner.
The time taken to reach the destination or financial goal, the speed (read return on investment) and safety (permanent loss of capital) and volatility (read risk involved in investing in various types of assets) and the intermediate experience are all based on four important factors: the number of vehicles on the road; other drivers’ behaviour; your own behaviour while driving; and, the ability of the vehicle.
ADVERTISEMENT
Vehicles on the road
The number of vehicles on the road is likely to be high during peak hours. In the early hours, driving will be peaceful because of fewer vehicles on road.
Driving in the early hours is like investing in years such as 2008 (post-correction) or 2012 or when no one wanted to invest in equity markets.
ADVERTISEMENT
There is less competition and you can pick and choose funds or stocks at a reasonable valuation that could yield desired returns over a long period.
Driving in peak hour traffic is like investing during a crazy market run such as in 2007 or 2017, when there is heavy competition. This could lead to higher valuations and hence give lower returns — due to either prices being stagnant or due to a significant fall in prices, as was the case with the correction in mid- and small-caps in the 2018-2019 period.
Others’ behaviour
Equity investing in the short term is largely affected by the behaviour of market participants. Over the last 1-2 years, price correction in a lot of mid- and small-cap companies have been severe due to valuation de-rating (this stems from a lower expectation of future growth from market participants).
Being cautious during market highs and being aggressive when the market falls is essential to realising better returns.
During a peak market, you need to manage risk by investing in tier-1 (ie, the best companies) and by not investing in tier-2 and -3 companies though the latter’s valuation may seem lower and could see higher speculative activity.
During market lows, build a portfolio for future returns by investing in firms that have the balance sheet to fund growth using internal cashflows and which have large reinvestment opportunity; avoid investing in ‘cigar butt’ ideas where only valuation re-rating is possible and no growth in intrinsic value may be expected.
Your own behaviour
Change your behaviour if you want to change what happens to you or around you. By wearing a seat belt, coupled with cautious driving, you choose to drive safe and avoid major accidents, or at least protect yourself in a mishap should one take place.
The probability of an accident is low but its impact could be high. In investing, the amount to be invested in various assets such as equities and fixed deposits needs to be considered based on the risk tolerance of the investor and the time factor.
A poor decision could mean a portfolio that belies expectation. For example, investing in equities with a short time horizon could lead to loss and increase the risk level of the portfolio. Similarly, investors need to step up purchase of equity assets at lower multiples (valuations) to improve returns.
A fall in the markets can been seen either as a risk or as an opportunity. A temporary fall in the market is considered risky by investors who panic and exit the market; the same temporary fall is seen as a call to action by those who wish to deploy capital for the long term.
Any net saver should welcome a fall in markets as the net incremental money is deployed at lower levels and not at higher levels. A market fall gives investors enough time and opportunity to research on companies or funds and invest at attractive valuations. (ie, good stocks bought post a crisis such as in 2008, 2013 and early 2016 have, in general, yielded better returns).
Being defensive in a declining market is the equivalent of driving too slow in a highway where you need to be in top gear instead of in third gear.
Not taking risk by accepting short-term volatility in the portfolio could lead to long-term risk of not reaching the desired corpus target.
Ability of the vehicle
Some vehicles are designed for high speeds and some, for reasonable speeds. You choose a vehicle or an investment instrument based on your comfort and need. If your style fits an aggressive form of driving, then you need a vehicle with a high-power engine.
Similarly, in investing too, choose instruments such as stocks, mutual funds or fixed deposits depending on what suits your temperament and what your needs are, to reach your financial goals in a safe and timely manner.
Happy Investing!
(The writer is Head of Research and co-fund manager at Ithought Financial Consulting LLP)