Overlooked But Essential
Present day investors are growing ever more aware of the importance of viewing investing as one solitary aspect within the wider ambit of personal finance. And with time, aspects such as investment behaviour, asset allocation and process oriented investing are also beginning to receive due importance. But there are still a number of aspects to investing which are constantly overlooked by investors, even though they are just as important as those aspects which recieve their fair share of the spotlight. So in today's blog post I'm going to throw some light on these aspects of investing which are overlooked but essential.
The first aspect that I would like to throw light on is the dilemma over the right time to begin investing. Most of us usually try to wait for the perfect time to begin our investment journey and that usually puts us at a major disadvantage. Therefore, we must ensure that we begin investing as soon as we start working and earning without waiting for a utopian situation.
The fact that we begin our investment journeys as soon as we begin earning automatically means that we give ourselves a leg up over most other investors, by instilling in us the discipline of saving every month and investing our savings in a timely and systematic manner.
But, in order to achieve financial independence systematic saving and investing alone would not do. Most of us are of the opinion that investing regularly as per an asset allocation strategy is the be all and end all of a sound investment process. But that is just the bare minimum of what is required. A sound investment process combines systematic saving and investing with the ability to hunt for opportunities in various asset classes and make the most of them whenever they present themselves. And it goes without saying that most opportunities worth taking only present themselves during a crash in a particular asset class. Therefore, we must also use every market crash to our advantage. But, taking advantage of a market crash is a highly misunderstood aspect of investment process. Making the most of a market crash does not simply mean putting money into a depressed asset class. Everything that we do in and around a market crash must be driven by logic and purpose. Therefore, following a written investment strategy is extremely helpful during a market crash. The strategy should cover not only the list of investment products we want to buy, but also position sizing, how often we would deploy our money and how we would go about scaling our positions over time.
But in order to put our strategies into practice, we would need to have the right amounts of money available at the right time. This is where the second aspect that I want to talk about comes in. Every single one of our investment decisions must not be geared towards maximising investment returns. Our investment decisions must also be geared towards creating a robust base of liquid assets. Liquid assets include assets such as cash, liquid funds, savings bank deposits and other such assets which are easily convertible to cash. Liquid assets may not produce the best investment returns, but they do provide us with the means to take advantage of opportunities thrown up by the markets. This would automatically translate into superior investment performance in the future. Therefore we must aim to channel at least 20% of any surpluses we have available to invest into liquid assets. We can also make it a point to dedicate 5-10% of our monthly savings towards creating a base of liquid assets. It is important to keep in mind that any amount set aside as an emergency fund should not be included in our base of liquid investments. The use of emergency funds must be restricted exclusively to helping us meet financial exigencies. Following this approach to creating a base of liquid assets would not only allow us to take full toll of opportunities given to us by the markets, but also ensure that our finances remain crisis proof at all times.
The next aspect I would like to talk about is the importance of understanding our risk profile as investors. Now, most investors normally make blanket statements regarding their risk profile which sound like "I am an aggressive/conservative/ moderately aggressive investor." This is because they usually equate their risk profiles to the amount of equity exposure that they have in their portfolios. But, our risk profile isn't just meant to tell us how much we can invest in equity or any other asset class. It gives us insights into how much risk we can afford to take and how much risk we are willing to take, and helps us come to a satisfactory reconciliation between these aspects. All of this must always be done in light of our circumstances and financial situations. Self awareness is therefore extremely important for us to understand and judge our risk profile. Being self aware when we go about managing money automatically helps us realise how much money we can put at stake, how comfortable we are losing money and how we go about dealing with money, which is what risk profiling is ultimately all about. A well constructed risk profiling test can also help in this regard. I have spoken at length about various aspects of risk profiling in an earlier post titled Risk Profiling Made Effective. Feel free to have a look at it after reading this post.
The next aspect to focus on is safeguarding our investments effectively. Safeguarding our investments is simply about approaching our investment operations the right way. Whenever we make an investment, we must approach it in a way that allows us to build our positions over time and complete investments in a way that makes us comfortable with our investments. This would allow us to give our investments enough time to grow and turn into integral parts of our portfolios. This means that we must never pump all our money into an asset or asset class in one shot, even when attractive opportunities available. Doing so would leave us with no money to take advantage of a situation where prices get depressed further after we are done buying our desired investments. And it is even more important to have a plan of action for the eventuality that things do not go as we had planned in the real world. Entering an investment without an exit plan would be like jumping into a well, without a rope to pull ourselves back out. Working with an exit plan therefore ensures that we don't get caught off guard by anything the real world throws at us.
Lastly, we must also understand the impact of inflation on our investment performance. Most of us already know that it is important to generate inflation beating returns on our investments. But, investing in an asset or asset class that beats inflation handsomely one year and fails to beat it in the next few years would ultimately take us nowhere in the grand scheme of things. This is because beating inflation is a marathon and not a sprint. Therefore, we must always aim to beat inflation through returns that are realistic, achieveable and most importantly, sustainable. Also, inflation is always linked to our cost of living. Therefore, those of us who lead a frugal lifestyle are likely to be less severely affected by inflation compared to those of us who lead a relatively more extravagant lifestyle. Therefore, working with headline inflation numbers when setting a return benchmark may not always yield realistic results. The most effective return benchmark would therefore be the level of inflation associated with our individual financial goals. For example if we are planning for our children’s education, and education cost inflation is say 10%, our portfolios must return 10% per annum or more.
To sum up, we must begin our investment journeys as soon as we start earning. In addition to our regular investments it is important to build up a robust base of liquid assets to allow us to take advantage of opportunities provided by market crashes and guard our finances against crises. We must always have a clear understanding of our risk profiles and ensure that the risk profile of the assets we invest in and the risk profile of our portfolio as a whole matches our own risk profile as individuals. We must build positions in our investments gradually and ensure that we enter investments with a clear exit strategy prepared in advance. We must look to beat inflation through returns that are realistic, achieveable and sustainable. Our investment returns must be benchmarked to the inflation rates associated with our individual financial goals. All of these aspects may look unimportant. But they are essential to superior investment performance, and hence warrant our attention.
