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How afraid are you of losing money? The answer to this question will determine whether you are a suitable equity investor and how you should consider the current sharp fall. Looking at the 10-day 16% fall in March, in benchmark equity indices or in other words ‘the market’ you may be feeling the pain.
I know I am!
The current situation aside, if you were asked this simple question with a multiple-choice answering sheet, what would you tick?
How afraid are you of losing money?
- Very worried
- Worry sometimes
- Not so much
- Not at all
You may give it a few seconds thought and usually, the answer will depend on what you can remember immediately as your bank balance. If you feel you have enough, you’ll probably end up going with option b or c. Someone with an unlimited pot of money, won’t be worried even today, but if you have just started working in the private sector and started your investments in equity mutual funds, you will probably be very worried.
However, the answer to this question, when seen in the context of investments, will be complete only after you answer at least two more questions. Even if you are feeling very afraid today given the situation in the economy and in the capital markets, take a pause and answer the next two questions for a better perspective.
How you feel about money is important
Before we go on to the next two questions, understand that your answer to the first question is important also to gauge your ability to take risk. If despite the slowdown in the economy and fall in returns from investments, you are still not concerned about losing money then you may be indifferent and it means you have a lot more to put at risk or it might mean that you have been investing for a few years already, have a secure job and understand the cyclicality of capital markets.
If on the other hand you are always worried about losing money regardless of the external situation and your accumulated wealth, it might mean that your ability to take risk is low and having high exposure to equity assets is probably going to make you panic in the current scenario.
How you manage your behaviour when your money or investments are impacted by external factors or when the risk gets real depends on how you feel about money. Too much insecurity makes you turn to safe or risk-averse investments and too much confidence about money will make you take more risks. Ideally you need to be somewhere in between – never too secure and never too confident.
Time matters
When it comes to investing in capital markets, losing money is a reality. The question is for how long? Hence, what really matters is your time horizon. The longer you have the ability to remain invested, the more you stand to gain and the better your capital protection is thanks to gains which have piled up over the years.
If I change the first question slightly and ask ‘When are you most afraid of losing money?’
- Now
- After 1 year of investing
- After 3 years of investing
- After 5 years of investing
- After 10 years of investing
If it’s options a, b or c, you will not be able to stomach equity risk and surely this recent correction will send you packing. But choosing option d and e is perfectly rational even for equity investors; as long-term investors, we seek to make enough returns in 5-10 years to be able to beat inflationInflation is a common term thrown around in economics lessons and by politicians around election time. What it means in simple language is that prices of things you buy, stuff, keeps increasing every year. It happens because the economy in... More and create wealth.
Afraid for all your money or a bit of it?
If your pot of savings is say, ₹1 lakh, you may be willing to accept some loss of capital but not all even after 10 years. Let’s alter the question one more time.
How much of your savings are you afraid of losing today? (i.e. don’t want to lose)
- All of it
- Afraid of losing 70%
- Afraid of losing 50%
- Afraid of losing 20%
If you have marked option a, then definitely equity is not your game. It simply means you will be unable to place any money at risk even for a day. Depending on where you fit in option b, c or d, your ability to stomach equity risk on any given day can be ascertained and based on this and the answer to the previous question you can determine your equity allocation. Most of us will be somewhere in-between option c and d.
At the end of it, after all three questions are answered, most you will realise that you are perhaps afraid to lose some portion of your money today and there is a portion of your money that you can keep aside and not be afraid of the change in value for 5-7-10 years.
But I just started investing….
You heeded the advice of this blog writer and others encouraging you to start investing early. Began a systematic investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More plan (SIP) in an equity mutual fund recently, only to be beaten down to deep red?
If you are young, in all likelihood you have no major financial responsibilities and when it comes to losing money let’s assume you aren’t afraid to lose up to 80% of your savings. IN which case, the current fall in equity markets, while unnerving, should not result in a change in your investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More approach.
Now if you started your SIP investments in equity funds in January and after three months, your SIP accumulated value is down 15% or more, should you panic? Not really. Assuming you have a stable job on the path to growth and again no financial responsibilities, you have time on your side and aren’t afraid to lose some value today or in other words, can wait for your investments to accumulate value over 5-10 years.
Ideally, you should start worrying if you are still losing money after 5 or 10 years of investing. By then you may be planning your own marriage or may have young kids and suddenly all this accumulated saving and investments begin to matter.
For now, continue your SIPs and if you have the ability to add more to your equity investments then top up your monthly SIP amounts so that you have added more when prices are lower.
How much more red will I have to see?
This is a crystal ball question that no one can answer precisely. In all likelihood, you will see more red. Read this article that I wrote for an advisory platform which showcases what history teaches us about market returns.
There may be more pain, but after that to take advantage of the gains – it’s most important to remain invested. Not only that, but you must also continue to increase your investments regularly to take advantage of lower prices in the equity markets.
Going back to where we started, before you can do all of the above, recognise how afraid you are of losing money and then plan your investments in equity. Remember also, you need to have a mix of equity investments built into your portfolio so that you are able to create long term wealth. The operative word if you have just started your market-linked investments is long term – 5/7/10 years or more!