Covid-19 is one of the worst humanitarian crisis mankind has faced in recent times. Under a lockdown, we all are facing fear and anxiety in the wake of uncertainty. However, this ironic situation of a lockdown can also be viewed through a positive lens. It has taught us many things – to slow down and reflect, appreciate nature, optimise resources, value relationships, etc. And, there are financial lessons to learn as well.
First and foremost:
Emergency Fund: The primary thing today for mankind in these precarious times is about survival.
When will the lockdown end?
Will it extend another month, may be two, three?
Will the monthly income get affected? (The nightmare is already coming true for many)
But one thing Is certain. There are household bills to pay every month. During these turbulent times of uncertainty and anxiety, nothing can be more stressful than the lack of money. When a crisis hits us hard, challenging our basic survival, then we realise the importance of basic and mundane things in our life which usually we take for granted. Emergency fund is one of them. Everyone inevitably keeps some money in savings account. The rationale is to have some liquid money for any kind of emergency. But most people do not know whether it would be adequate or not when a critical time arrives. Many also equate an emergency fund only to some health emergency or sudden hospitalisation. But an emergency fund is also useful in uncertain times like the present one. Layoffs, pay cuts are inevitable when all economic activity of a country is hugely affected.
So, can you imagine how many months you will be able to live on emergency fund without your job? There is no rule of thumb here. Financial planners usually advise people to keep an emergency fund equivalent to at least three months of living expenses (bills, insurance premiums, school fees, EMIs). But this could extend to over 3 months, depending upon the professional and personal situation of a person. For e.g., someone who is self-employed or working in a start-up or a high attrition industry like IT, the emergency fund should be greater than 3 months. Even for a person who has a pre-existing medical condition like diabetes or some earlier history should maintain a higher emergency fund.
So, evaluate your emergency fund. Introspect whether it is adequate. Shore it up gradually if you think it’s not enough. Never ever touch it for other purposes. The aim is to be financially prepared when life throws those harsh bouncers at you.
2. Asset Allocation: Risk and return are two sides of the same coin. Higher the return, higher is the risk an investor needs to undertake. Yet, majority investors forget this when the stock market party is on. Reality dawns when the markets crash as seen in the current times. Markets can be real cruel wiping off even 10-year average returns in a brief period. This is not uncommon though. But time and again, investors do not learn an important lesson here – which is investments is all about asset allocation. It is the cornerstone of successful investing.
Asset allocation is to successful investing just as a balanced diet is to good health. We eat a balanced meal to procure proteins, carbohydrates, vitamins, fats, etc. Excess presence of any of these in our body can affect our health. Similarly, we need to have a diversified portfolio of different investments which range from safe, low risk and high risk. The presence of each asset class, be it debt, equity, gold, etc is relevant in a portfolio. While equities provide growth to a portfolio to beat inflation, the debt component (fixed income) lends stability and safety in the scenario of falling stock markets. It is thus important to view your portfolio in totality and not on a piecemeal basis. This will ensure that you do not take too much exposure to any one asset class which can affect the portfolio performance.
Ensure to allocate your investments in such a manner which are in line with your age, risk appetite, your financial goals and the time horizon to achieve them. Further, one important aspect of asset allocation is periodic monitoring and rebalancing of portfolio due to market fluctuations.
For instance, assume you have a portfolio with 60 per cent equity and 40 per cent debt. Now, suppose with fall in markets, your equity component in the portfolio went down to 55 per cent and the debt part increased to 45 per cent. Here, you can partially redeem the profits in the debt bucket and invest the same in the equity bucket to bring the allocation to the original 60:40 ratio. This is called rebalancing the portfolio and needs a periodic review. Rebalancing helps to tide over volatility in the markets. During extreme downfalls, it offers an opportunity to invest in a disciplined manner and during peaks, it presents an opportunity to book profits as per the desired asset allocation.
When we focus on our financial goals and view our investment portfolio in totality, chasing the peaks and troughs of stock markets become a futile exercise. Invest in a disciplined manner regularly as per your asset allocation and redeem only when your goals are nearing or when rebalancing the portfolio. You can seek the advice of an expert financial advisor who can guide you in asset allocation.
Let your money compound and grow over the longer run. That is the sure shot way to create long term wealth. Hope these two lessons will help you to ponder and reflect on your personal financial situation. Take care and stay safe.