It's the survival of the fittest: Tips to be fit

Last time, we talked about King Solomon’s ring and the message inscribed on it, “This too shall pass”. The message was fairly simple to keep balance in boom or doom. However, it’s important to survive through a bad period. While this too shall pass, it’s a game of survival. We have to survive through a bad or a lean period, else we may not be there when the situation changes for the better. The survival can be achieved through proper planning. Prudence plays a major role. A balanced mind can help.

Why are we talking about survival? In the current scenario, many portfolios have shrunk in size simply due to loss of value. But that is less of a problem. If the portfolio is built with appropriate homework, “this too shall pass” and one would see the portfolio value rising again once the markets turn around for the better. The bigger problem in the present situation is that some of us may lose our jobs. Now that would be a serious issue. The investment portfolio may have been planned with an assumption that one’s income is stable. Such an assumption allows an investor to keep minimum amount invested in short-term liquid investment options. The objective of such investment options is to provide complete safety of capital even if it means earning at low rates.

Often people keep liquid investments of up to three months of earnings. However, an assumption that the earnings are going to be stable allows an investor to keep almost nothing in liquid investments. Such a strategy frees up the investment capital to be invested to meet long-term goals in risky (volatile in short term) assets that can provide growth of capital. The chances are that in such a case, the investor loses capital as the riskier assets, that is, equity and real estate, have lost value. If the investor is unable to find another job, or considers starting a business, liquidity for the initial period could become an issue and that is where survival becomes difficult.

Investment planning suggests that one must have enough surplus to survive through lean periods. As per a thumb rule, keep at least three to six months worth of expenses or earnings in the bank. However, as mentioned earlier, such thumb rules are based on the assumption that the income from one’s job is safe and that the income is sustainable and the person is employable.

Looking at the investment portfolio only, if the money is invested in real estate or equity that loses value, one is still in a position to fetch some value as there is a price being quoted in the market. Even by booking a loss, one can get some money through liquidation of such assets. This cushion could be helpful in times of crisis. In certain cases, the investment options chosen are not the asset themselves but the derivatives of the assets. Let us say, investment in equity is done through equity derivative contracts. Equity as an asset class is suitable for longer terms. However, the derivative contracts are available only for short periods.

The nature of derivative contracts makes them low-cost to buy but extremely risky if not used properly. When you buy protection against fluctuations through derivative contracts, it better be affordable. That is why when you want to buy protection for assets worth Rs 100, the premium (or margin) you pay may be around Rs 15 to Rs 20. However, if derivatives are used for the purpose of investment (often it is speculation in the garb of investments), then one is risking the entire premium or margin paid. In such a case, if the investor encounters volatility, it is possible that the investment may not survive long enough to see the turn around.

Leverage or borrowed money is another such example, which shortens the longevity of one’s investment portfolio in turbulent times. We talked about the perils of leverage in the article: “Why are markets taking a nasty ‘U’ turn?”

Lastly, remember the wise words of John Maynard Keynes, “Markets can remain irrational for longer than one can remain solvent.”

- Amit Trivedi

The author is proprietor of Karmayog Knowledge Academy. He can be reached at karmayog.knowledge@gmail.com