We are living in an extraordinary time, and sometimes it is hard to believe if everything happening around us is for real or not. Across the world, businesses have shut shop; people locked up in houses, deserted streets, supplies short, and fear looming in every corner. World over, the stocks markets have behaved in a manner expected, with a sudden and intense fall in stock prices, last seen only in February 2008. The Indian markets have crashed nearly 35% from its peak, wiping out a couple of billions of dollars from the economy. Here are a few financial tips from Nithin Kamath, Founder & CEO, Zerodha in these tough times.
With everything that’s happening around us, there are few valuable life lessons the current situation is teaching us. These are both general life lessons and financial lessons. I’d like to highlight two critical financial lessons given the current situation.
Build an emergency corpus
The current global situation has driven many businesses to close down or brought them to a brink of collapse, especially in the hospitality, services, airlines, travel, and tourism, consumer lending, and lifestyle sector. Many people employed in these sectors have already lost their jobs. In the US, the unemployment insurance claims have hit an all-time peak, last seen only during the 2nd world war.
For people who have lost their jobs, it may take a couple of months before they find another job and limp back to a routine lifestyle.
During this period, you don’t want your family or your dependents to suffer. A financially prudent person with an emergency corpus can tide through this situation.
For others, life can be quite harsh. It is perhaps a good time to reflect on your finances and plan to build an emergency corpus.
The obvious question is how much is good enough as an emergency corpus. The popular opinion is that you need to have at least six months of expenses stashed away as emergency corpus. In my opinion, this is not fair. Each household is different with different requirements. Hence, you need to work out the corpus yourself and not by the six months philosophy. Here are a few guidelines –
1) Factor in your monthly EMIs – have at least 6-8 months of EMIs buffered in your emergency corpus
2) Budget for your monthly household expenses – a buffer for at least 6-8 months
3) Budget for unforeseen expenditure during this period, something as trivial as your washing machine breaking down during your jobless days.
4) What if you, unfortunately, meet with an accident during this period? It is always prudent to buffer additional cash for situations like these.
The point is that you cannot bankroll on a standard 6-month household expense for the emergency corpus. You need to think through your situation and plan for the emergency corpus.
If you do not have this fund with you today, then don’t worry. Work out your total emergency corpus amount, break it down into 10 or 12 monthly instalments and start saving that amount every month. Think of it as a systematic savings plan. Build this corpus first and then think about your other investments.
Lastly, the definition of an ‘emergency corpus’, is that it should be available to you when you need it. Hence, do not park this money in any sort of deposits or investments with lockin period. Place this money either in your bank’s savings account or in a liquid fund.
Build an Index portfolio
Think about investing in stocks for a moment. What do you think is the underlying assumption when you invest in your favourite company for the long term? By long term, I mean five or even ten years. Yes, I agree the assumption is that the returns will roll and your investment will eventually make you wealthy. However, I’m concerned about a more basic premise here, which often goes unstated. The assumption is that the company you are investing in will survive many decades or even years.
What if it does not survive? What if the company you are investing turns out to be a Yes Bank or a PCJ? Unfortunately, under such a circumstance, all your hard-earned money gets flushed down the drain.
Given this, it is imperative to acknowledge and estimate the likelihood of survival of your investment. Unfortunately, this is a very complicated task, and one has to run through several sensitivity models to determine the survival likelihood. As you can imagine, this is out of reach for most retail investors.
However, investors can instead invest in an index fund. If you think about it, an index is designed to survive. The index constituents are evaluated continuously and cleansed. At any given point, the index consists of the biggest and the most reliable names of the underlying economy. Hence, the survival of the Index itself is not a concern.
The Dow Jones and S&P 500 in the US has survived several decades if not more, the Sensex and Nifty in India has survived for a few decades, while the constituents within the indices have changed over time.
So what does this imply? It implies you, as an index investor, should not worry about the survival of your invested asset, which in itself is a massive edge over other investment options.
So, if you don’t have an index portfolio, then this is perhaps an excellent opportunity to get started. The index has crashed over 35% from its peak. Unfortunately, one cannot call the bottom, but you indeed should get started by staggering your investment. Once you start and set up an Index investment, continue investments systematically every month, just like the way you’d with an equity mutual fund.
I’d recommend you to invest in any direct index fund or ETF. Lastly remember, investment in the index fund is one component of your overall portfolio. Do consult your financial advisor to help you with a portfolio with the right asset balance.