By Raj Talati
My high school teacher posed this question to our class one day: There are two watches. One watch slows everyday by a second and the other is not working. Which watch would you buy?
Obviously, the consensus was on the watch that slows by one second per day. What if the same question is posed to a computer which uses logic? It might go for the watch that is not working. Why? At least the watch will show the correct time at least twice in a day, whereas the other one will show correct time after more than 100 years.
In times of post artificial intelligence, a computer might opt for option one. Even if we make two robots exactly similar, with similar information and analytical power, it is not possible to get a different set of results in same situation. An individual, unlike the machines, would behave differently even in same situations across different time periods.
Even similar twins will not make similar decision or have exactly same liking or life. Will they chose same career path? Will they have same taste for food? Will their selection for a bride or groom be similar? Not necessarily. So, how is it possible for them to have a similar financial portfolio?
That is the reason why an investor who was aggressive during a bull cycle continues to be remain aggressive up to a certain level of fall in the market. He suddenly becomes conservative after that. The only reason is: human brain doesn’t think everything in terms of zero and one and every decision is made after keeping in mind a lot of emotional aspects and situational externalities. Two individuals are bound to have different biometric identities and similarly every individual is bound to have a different risk profile. It is very important to understand that every individual is unique. The biggest differentiating factor between goal planning/investment planning and financial planning is risk profiling.
At most junctures, an investor invests in a fund or an asset class according to its past performance. Considering the past performance to be only one of the determinants, a financial planner knows it is more important to have a proper asset allocation than tracking the best fund. Tracking the best performing fund or asset class is a futile activity like driving a car while only looking at the rear view mirror. The past performance is past and doesn’t offer any guarantee for the future. It can provide us with certain data points to help us take informed decisions, but future always tends to throw something new (Even on fund performance, risk makes a big contribution. We will save that discussion for some other time, as we talk about individual risk profiling in this article).
In personal finance, ‘personal’ is very important together with finance. It is personal and hence is required to be in tandem with individual needs, situation, financial crisis or stability of past, job, number of kids, dependent parents, assets, liabilities, expenses etc.
As advisors, the only things we are certain about are: client goals, needs, risk profile, expenses, spending pattern, and lifestyle. We do not have any control over economy, inflation, interest rates, equity/gold or real estate prices, government changes, pandemics like corona, oil prices, exchange rates, fiscal deficit, balance of payment and monetary policies. These factors can even take the world’s best investor, equipped with the best data and information, by surprise.
Even thumb rules are ineffectual. Let us assume the situation of a 28-year-old BPO executive who got married recently and took a loan to buy a house in Pune. Going by the thumb rule, he invested 72% (100-age) in equities. What would be his situation in this market condition, when he is uncertain about his salary or job and has an EMI to pay? If laid off, he would have to sit at home and watch his hard earned money tank every day. How will he ensure to pass through this period of uncertainty?
The post-independence generation, for the first time, has understood the importance of freedom. Likewise, millennial investors, for the first time, amidst this crisis, are on course to learn the importance of financial security. It reminds me of a few lines from Jagjit Singh’s Gazal :
Ghar Sajane Ka Tasavvur To Bohat Baad Ka Hain
Pehle Yeh Tay Ho Ke Is Ghar Ko Bachaye Kaise.
So as an investor, we should control what is in our hands. While planning for financial freedom, goals are important but financial security would come only if the investor invests as per his risk profile.
The three aspects to evaluate risk profile are:
Willingness to take risk
Ability to take risk
Need to take risk
But it should be seen in conjuncture with other variable type of business/job you are in, dependents, age, other liabilities, expenses, life style etc.
It is not a one-time process and needs continuous evaluation of situation.
I quote: “Markets can remain irrational longer than you can remain solvent” – John Keynes
The biggest benefit of financial planning is it takes care of wealth protection, wealth accumulation and wealth distribution. Every investor should follow a financial planning pyramid according to which the foundation would be laid by the creation of a contingency/emergency fund, insurance planning can further help to mould the structure, and eventually goals and wealth distribution can be taken care of.
The right time to evaluate your risk profile is during initial investments. If not, this crisis offers an opportunity to restructure and reevaluate the risk profile as well as the investment portfolio with the help of a professional. A long-drawn strategy, through consultation, might help to realign the portfolio as per your profile.
(Raj Talati is a Certified Financial Planner and partner at ABM Investment, Vadodara.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
