Risky Investment strategies

You are a young 35 year old couple and are saving for multiple goals – being debt free, buying a bigger house, children’s education, being a reserve in case either parents run out of money, …etc. You sit down as a couple and are reviewing your portfolio, what do you exactly do? Lemme guess

  • you see how your portfolio is doing
  • you even compare it to a big broad index
  • you even go to a couple of websites like Morningstar and see whether your fund is rated well
  • If you have an equity portfolio you are very happy that ALL your shares have gone up

Right? Well most people do this.

What have you missed out?

You have missed out the risks in your portfolio. If all your funds and all your equities have gone up at the same time, remember at some point in time, they could all be in the red! You need to ask yourself – are you using some risky strategies? All your shares or funds moving in the same direction is a potential sign you have not paid enough attention to diversification.

Diversification is not just about having more than one share – in fact having one well diversified fund is enough when your sip amounts are small. Diversification is about having many shares, across multiple sectors, management groups, geographies, countries, currencies, industries, etc.  In such a scenario if your full portfolio rises simultaneously, this suggests they are all responding to the same key factors and drivers. That is RISKY INVESTMENT STRATEGY. A well diversified portfolio will spread out investments across categories that respond differently to different factors and drivers. For example if you owned Ongc, Selan, Hoel, Hpcl, and Indigo – see how each one will react to oil price hike (or fall).

Many investors think owning more than one share is diversification. This is only partially true. Owning Hpcl and Bpcl is hardly any diversification. Owning EID PARRY gives you a flavor of fertilisers because it is the holding company for Coromandel International, etc etc. Owning 2 companies in the same industry diversifies only one type of uncertainty: company-specific risk. So if you held Satyam, Infosys, and Wipro, you were saved from the risk of owning only Satyam! While it could help protect you from the risk of having all your money concentrated in a Satyam -like house of cards, it won’t protect you from higher-level concerns and considerations.

How much do you withdraw annually, and could you cut it if you had to?

 This might seem like too early to answer and far away question, because not many people think of withdrawals as a risk. Check out your parents portfolio if they are living off their savings. It is a real crucial consideration in retirement planning — particularly for investors early in retirement. Assuming that your parents are 65 years of age, they must be grappling with this. A great place for you to learn.  The ONLY PURPOSE of a retirement portfolio is to fund the years when you aren’t working. The biggest risk you face during that time is depleting your assets while you still need them. And, annual withdrawals typically put the greatest strain on your portfolio during retirement. Obvious, is it not? Well not too many folks think like that! Start learning about it NOW. Not learning is high risk.

You can calculate your annual withdrawal rate (or for your parents) by using your online-access tools. It usually is not too difficult to learn! Your parents may feel overwhelmed with all this, so help them through it.  Total the past year’s withdrawals, and then divide that sum by the value of your portfolio at the beginning of the year. The resulting number is your withdrawal rate for the year. How much have they withdrawn? Is it high? Is it 13% or is it a nice 5% -or are they able to live just off the dividends? Well if it is 12% and the corpus is NOT HUGE (obviously) you have a major, acute and immediate problem in need of rectifying. NOW. Even if it is a more manageable level — 4%, 5%, 6% — you should consider the some of the worst-case scenario and assess how you would live if you had to slash this amount by a quarter or half. Write down your plan. Maybe your parents did not do it when they were 35, but no harm in preparing. Too young? ha time flies!

 Having flexibility in your withdrawal rate is a big depletion-risk reducer. If you can create an all equity portfolio and be able to live off the dividends, you have reached the golden point of being financially free. Even if you are just 35.  Even if you presume you will perfectly foresee every market downturn from here – which you will obviously not – it is wise to humbly prepare as though you won’t.
Overconfidence kills.

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One Response to “Risky Investment strategies”

  1. Subraji,

    This situation is unique to current generation and henceforth. Last generation either has defined pension or supported by children in old age. Current people in 35-40 bracket has none of this plus people are competing each other in lifestyle – all they have is temporary employment plus no children support in old age.

    The best they should do is to live a simple lifestyle. I had made myself FI by 35 – people were laughing at me for frugal lifestyle when they were buying bigger houses, fancy cars, gadgets, clothes, movies and eating out regularly – now my family can live comfortably on 1% of corpus annually and I can work in whatever job I get without any stress of losing it as it keeps on adding to my corpus.

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