I could have called it “My Own Boswell” but Late Justice Hidayatullah (Ex Chief Justice and then Vice-President of India) beat me to it.
Here is a an article from a regular reader….
They say that “If you don’t look back at your past self from
a year ago and feel ashamed, you aren’t progressing enough”. While this may
seem like an aggressive quote, it does apply very well to someone who’s just
starting out in a new field. It’s certainly been relevant for me as I look back
on my personal finance journey spanning a grand total of … 2.5 years.
But first, some background –I got into personal finance in
early 2018, at the age of 21, in what was a pretty unusual way to enter the
field. I started by reading books like John Bogle’s Little book of Common-sense
Investing, The Four Pillars of Investing (highly recommend this), and A Random Walk
down Wall street.
While these are good books in their own right, it meant I
had tunnel vision as I entered the markets with the view that only index funds
(+ active funds, in an Indian context) worked on a consistent basis. This
reductionist view of the markets was helpful though, as I stayed away from the
likes of trading, F&O etc that were outside my circle of competence.
I got some of the basics right – 6 months emergency fund, minimizing
my Income tax, investment tracking, term insurance (although I did end up
adding a couple of riders) but my naivety was still visible in my thought
process re: equity. As far as I was concerned, equity was this magic wand that
worked in the ‘long run’ and I could even see myself at the ripe age of 60
counting the millions made through a smooth 12% CAGR over 40 years.
I’d even gone as far as writing to my HR, as a fresher,
asking them to not contribute any money to my EPF but to instead give it to me directly.
Investing this money in an equity fund just made so much more sense (I did the
numbers on Excel. They don’t lie.). Needless to say, I’m now glad they refused. My own portfolio, of course, was chosen ‘carefully
and rigorously’ by looking at 5* rated funds from Value Research.
Fast forward to 2020 and I am now also in charge of my
parent’s finances. The lockdown gave me the perfect chance to take a deeper
look at the support structure surrounding our finances and to kick start the
planning for their withdrawal stage. Luckily,
my quest for knowledge coincided with me finding the Freefincal and Subramoney
YT channels and this proved to be a real game-changer.
While I got some granular details on how to choose my
investments better (Adding more mathematical rigor to my selection process,
understanding a fund’s history etc), the main value I derived from both Pattu
and Subra were the scenarios where things can go wrong, or have gone wrong in
the past. I’d argue that this is just as important, if not far more, than
knowing what/where to invest. This concept is best encapsulated in a mental
model called ‘Inversion’.
Inversion is a really simple, yet powerful, concept – If you
want to know how to become a better investor, flip/invert the question on its
head and ask “What makes one a bad investor?”. This inverted question is often
far easier to answer and coaxes out the exact pain points to address. Some
examples where Inversion has helped me are:
- How can I ensure my parents have a smooth
retirement? – Inverted: What can mess up their retirement journey? – Sequence
of return risk, longevity risk, lack of Insurance/emergency buffers to prevent portfolio
drawdown, inappropriate risk taking etc
- How can I ensure my dependants will be fine if
anything happens to me? – Inverted: What can cause my dependants to have
problems if anything happens to me? – Lack of insurance, will. Incorrect nominations.
Poor tracking & sharing of finances, important documents. Lack of insight
into how the money should be handled in your absence.
Adding my learnings together, I was able to come up with a
high-level framework of personal finance: A building that is supported by 4 key
pillars –Investments, Taxation, Administration & Protection (Or as my
friend Kaushik lovingly calls it – I.T.A.P.). While these pillars deserve their
own posts, an overview might be useful:
Protection – Adequate life insurance (To ensure your
dependants don’t struggle in your absence), Health & accident insurance (To
ensure the expenses don’t cause a financial strain & portfolio drawdown). Emergency funds and possibly, a medical
corpus.
Investments – Asset allocation, risk management, goal-based
planning…. The usual gospel
Taxation – Minimizing the amount you pay to the
taxman and the corresponding impact it has on your portfolio. Understanding the
power of capital gains vs income tax
Administration – This is arguably the most important,
and the most overlooked, pillar. It encapsulates a wide variety of actions
ranging from financial tracking to the formation of a continuity plan (To
ensure your dependants can continue in the case of your demise). Central to
these are ensuring that wills are made, the right nominations have been
selected/updated, and the sharing of important documents.
The real power of the framework comes not from viewing the
pillars individually, but holistically. What gives our investments the
breathing space to work well in the long run, is the supporting cast around it.
Protection covers for the rare, high impact scenarios that can really hurt your
portfolio. Administration ensures that you keep proper track of your portfolio
and that there is a continuity plan in place. Without these support structures,
any financial journey is liable to be shattered at the onset of an adverse event
(Job loss, accident, death etc).
To end this post with, here are a few easy wins that can be
easily implemented for a better financial journey:
- Documentation/Will/Nominations – Once you’ve
started putting your money anywhere, this becomes an absolute must. It will be
a travesty for your dependants if they don’t know where you’ve invested or are
unable to access it. (Attach link to Freefincal’s MF tracker, Family must
know)
- Don’t only stress on the right investment
choice, focus on the holistic view of personal finance and how the other
pillars enable your investment. For your investments to run un-abated &
fulfil their goal, your liquid funds, insurances, & administration need to
work in tandem. - Inversion is an amazing mental model that can be
used to stress test your finances. Always invert and try to break down your
hypotheses and processes to identify any points of failure.
- Learning behavioural psychology, particularly
those topics relevant to our biases and the ways in which we fool ourselves,
can prove to be highly useful. This is key to ensuring one doesn’t get carried
away by various market narratives.
- “Over-diversification” will hurt in equities but
can prove to be useful in debt. I’ve made 2 mistakes in the debt space which
highlight this:
- Almost 60% of our liquid fixed-income
portfolio was invested in 3 Franklin funds, all of which were shut-down. As a
family, we were lucky to escape unscathed as my mother’s job was un-affected
and we were able to build up a decent buffer in the following months. This was
a real-life lesson on Credit Risk and I shudder to think of the ramifications
if this had happened during my parent’s retirement phase.
- We had invested in the debt of a foreign company
(Which does most of its business in India but is HQ’d abroad) which was
offering a great return (For the added risk, of course). Now, this was a pretty
good company that recently raised equity capital from the likes of Mukesh
Ambani but it was still in its early stages. We’d been investors since 2017 and
picked up the options to add more $, all while it silently crept up to 5% of
our entire portfolio. We’ve been incredibly lucky that this company was able to
weather the COVID-19 storm well (being in the real estate space, no less) but
that’s just too much exposure to an unlisted bond of a non-public company,
given our humble portfolio size. Outcome bias shouldn’t cause one to shirk away
from the fact that this was poorly handled by us.
Lastly, I want to thank Pattu for giving me the opportunity
to write this post and share my evolution as an investor. I’ve benefited
tremendously from the knowledge and resources that have been shared on this
site and am hoping to pay it forward by sharing my learnings. I am by no means
the finished article but I’m hoping this post gave you a few points to ponder
about.
Take care, stay safe, and good luck for the journey ahead.
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