20 Jun 2021

Stress is a response

I used to think that external factors caused stress in me. While that may not be entirely wrong, a more correct way to think about stress is that stress is a response.

Recently, I discovered that stress is my response to what happens externally. Stress doesn’t come from outside ready-made, but rather, I create the stress within me. Thinking this way puts me on the driver seat.

Various things happen beyond my control. Responding to many of them by getting stressed is unhealthy and unsustainable. Stress starts as a mental discomfort and quickly evolves into physical discomfort.

I have long believed that taking ownership of the problem is the first step towards finding a solution. I have spent a long time blaming my problems on stress, but I think the time has come to acknowledge that I have the power and responsibility to stop stress from entering my system.

17 Jun 2021

Asset allocation when you don’t have clear financial goals

I’m a big fan of goal-based investing and I’d recommend everyone to invest towards specific financial goals. But some of us cannot, or don’t want to, define goals. They just want to invest their money and get a good return. This post aims to give some guidance to such people.

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Let’s time travel back a few centuries, and imagine that you are a king or a queen of a state.  You split your citizens into 2 groups: a group of warriors and a group of residents. The Warrior group is always on the march: they go far and wide looking for new land to invade. The Resident group stays where they are and spend their days productively by farming, trading, etc.

Venn diagram showing your subjects split into warriors and residents

The warriors are rapidly adding more new people to your realm by capturing new territory. (Realm, I have just learned, is the gender-neutral word for kingdom.) They are also taking a big risk: many warriors get killed in this dangerous endeavour. There is also the risk of the entire army getting decimated if they engage in a conflict with a much stronger opponent.

The residents are adding more new people to your realm too, but at a much slower pace. All the newborn babies automatically become your new subjects. Because the residents are keeping the land productive and full of opportunities, people from nearby states might also choose to immigrate into your state.

You could say that the warriors are using a High Risk High Reward strategy to expand your realm. The residents are using a Low Risk Low Reward strategy towards the same goal. As their ruler, you appreciate how each group is adding value to your realm, and understand that they are both necessary for different reasons.

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Now let’s turn to investments. You split your investment assets into 2 buckets: a Growth Bucket that contains High Risk High Growth assets such as equity, gold, etc (disclaimer: I don’t invest in gold), and a Stability Bucket that contains Low Risk Slow Growth assets such as bonds, bank deposits, etc.

Let’s say you have a surplus of ₹10,00,000 that you want to invest. You can invest the whole sum in bank deposits, but the earnings will be low and taxes high. You want to invest this money in such a way that you get to make more returns without taking “too much” risk. The difficult part is determining how much risk is too much. When you follow goal-based investing, the asset allocation glide path tells you how much risk you can/should take at any given time. When you don’t have definite goals, you have to make do with guesswork or gut feel.

There are many ways to solve this, but here are some potential approaches.

Using a fixed ratio

Let’s say, for example, you’ll invest 30% of your corpus in growth assets and the remaining 70% will be in stable assets. Over time, based on how the investments appreciate, your asset allocation will regress from 70:30. You will periodically reset the asset allocation of the portfolio to control the amount of risk you take.

If the asset allocation has become 66:34, for example, meaning 34% of your corpus is now invested in growth assets, you’ll sell some of your growth assets and buy stable assets to bring the allocation back to 70:30. This is called rebalancing, and periodical rebalancing is crucial to keep the risk of a portfolio in check.

With a percentage based allocation, the amount of money you are risking increases as the investment corpus grows. Let’s say you start by investing ₹3,00,000 in equities and ₹7,00,000 in debt. After some time, your investment corpus has grown up to ₹12,00,000. 30% of this bigger corpus, ₹3,60,000, is now allocated to equity.

This method is analogous to having your army grow and shrink in proportion with the size of your realm. Over time, the investor might want to change their asset allocation based on their needs and preferences. A salaried person might be fine with 50% of their corpus in the growth bucket, but the same person might reduce it to 25 or 30% after they have retired.

Setting an upper limit on growth assets

You can say that you’ll invest a maximum of, say ₹5,00,000, in equity. That’s the amount of illiquidity you can afford. All your regular and unforeseen expenses will be met with the money you have in your stable portfolio. Periodically, say every 6 or 12 months, you’ll sell some of your growth assets to bring the Growth Bucket back to ₹5,00,000.

This method is analogous to saying that you don’t need more than a certain number of warriors irrespective of how big your realm is. You can say that a conservative investor will choose to do this. At any point, they know how much money they are willing to risk losing or locking up in potentially illiquid assets.

Setting an upper limit on stable assets

Now you are saying that you only need a maximum of, say ₹10,00,000, for any expenses you might come across. Everything else can be illiquid, and you invest them all in growth assets such as equity. Periodically, you’ll sell your growth assets to replenish your stable assets so you always have enough liquidity to manage expenses.

This method is analogous to saying that anyone who does not need to stay at home should become a warrior. You can say that an aggressive investor will choose to do this. You keep some money aside for your immediate (and near future) needs, and everything else is deployed as risky, potentially illiquid assets.

A combination of these

You can also combine the rules above to formulate a plan that’s very personalised to your needs and preferences. For example, 50% in growth assets until your corpus reaches a certain size. When your corpus gets larger, you’ll increase or reduce your equity exposure depending on whether you want to take more or less risk.

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If you are looking to invest some money, but are not bought into the “goal based investing”, I hope this post gave you some guidance on how to think about your asset allocation.