- June 4, 2020
- Posted by: peakalpha2023
- Category: Livemint
By Priya Sunder, Livemint article posted on 01 Jun 2020
“To redeem or not to redeem is the question”
Check if redeeming can cause further losses in terms of exit loads or taxability
My seven-year old golden retriever, Leo, is a rather feisty dog. Walking him each morning is an exercise in physical and mental endurance. He constantly yanks his 30-kg frame on the harness, lunges at unsuspecting walkers in the hope of a friendly pat, flips out when he spots a feline or bovine, and marks his territory with dogged determination on every parked vehicle. The 45-minute walk from my home to the army grounds and back is all the callisthenics I need for the day. While everyone notices his rambunctious behaviour, few know that Leo has an uncanny sense of direction. No matter how far I walk him or through which unfamiliar route I take him, he will always lead me back home safely. In the process, I have become fitter too, just keeping up with his boundless energy.
Leo’s conduct is akin to how the market behaves in the short term. It stalls, lunges, plunges and behaves erratically most of the time. But over time, it leads you to your destination and delivers healthy returns. All you need is resilience and patience.
The job of a financial planner is to establish a strong visual for the future and then guide the client in achieving that vision in the most efficient manner. In this journey, there will be several instances of planner-client dissatisfaction because the journey to achieving the end goal is fraught with pitfalls and negative portfolio returns in the short term. Long-term goals that are several years away cannot be achieved unless the short-term pain is experienced. It is almost a rite of passage.
However, events like covid-19 cause clients to forget their long-term plans and make irrational decisions based on market noise. If you are paranoid about your portfolio and feel the urge to exit because of the market corrections, ask yourself these questions:
One, has only your portfolio corrected or has everyone’s? Most equity portfolios have eroded anywhere in the range of 10-30% depending on when you invested. Hence, this is a systemic risk, not unsystemic risk that only you are exposed to. Systemic risks are easier to overcome since they are usually addressed by regulators, government and central banks.
Two, did your portfolio fall steeper than the markets? This is unlikely if your portfolio has the right allocation between growth and safety. If your portfolio had only 50% allocation to equity, your overall dip will not be 30%, but far less.
Three, is all your money invested in equity? If so, you have a problem. You must set aside a part of your portfolio in safe assets even if you need to redeem now.
Four, do you have enough money to deal with short-term contingencies such as a job loss or pay cuts? If so, do not redeem from your equity portfolio. Use the money in the savings bank or liquid funds to deal with the contingency. If not, redeem from those equity assets with minimum tax impact and exit loads.
Five, would redeeming from your equity portfolio sacrifice a long-term return of 10% for a safer debt investment that has a post-tax return of 4-5%? Would you, thereby, jeopardize an otherwise inflation-beating portfolio by your actions? If yes, do not redeem.
Six, would redeeming the portfolio cause further losses on account of exit loads or taxes? If so, refrain from redeeming.
Seven, is a short-term goal approaching soon? If you have money in safe assets, redeem from there. If not, redeem from equity and secure the money.
Eight, what is your best-case scenario? If it is one where you hold on to your job, meet short-term goals comfortably, and continue your investments to meet your long-term goals, then stay true to your original investment plan and do not redeem.
Nine, what is your worst-case scenario? If you were to lose your job and have no income for some months, determine if you can still meet expenses comfortably from your contingency fund. If not, then liquidity is key, and you may need to redeem from equity to meet expenses.
Ten, have you covered your health and life risks adequately? If not, do so right away, so you are not forced to redeem at distress or loss.
Once you are clear about how you will approach the above situations, you will make the right decisions now and for the future.
One of the biggest challenges for investors is closing the gap between their own portfolio returns and the fund or market returns. Often market returns are higher than investor returns because of human behaviour. We end up investing when the markets are high and pulling out when they are low. We focus on short-term performance and forego long-term gains. Above all, we do not practice efficient asset allocation and portfolio rebalancing. Efficient asset allocation requires staying away from behavioural biases of greed and fear. And, WhatsApp forwards.
