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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Fear the fear

Posted by Muthu on October 1, 2011

In the recent issue of Nanayam Vikatan, made a contribution in an article as to what quantum of one’s income can be committed towards EMI.

Borrowing implies spending tomorrow’s income today. Tomorrow’s income is uncertain and unpredictable!

Fear, worry, caution, skepticism etc. are definitely required. It is very difficult to survive in the financial jungle in the absence of these qualities. Many are not even aware of the kind of pitfalls and predators that are around.

But I do see enormous amount of fear around as if it is Armageddon tomorrow.

What we are seeing across the western world is the result of reckless borrowing, spending beyond means, lack of financial prudence and an erroneous belief that printing money would automatically mitigate the above risks and serve as a magic wand for stimulating the economies.

The Fed Governor Ben Bernanke is also called as ‘Helicopter’ Ben because once he said some thing like that the easiest way to stimulate the economy and fight deflation is to throw money from helicopter.

When excess leveraging happens, it has to be followed by de-leveraging. Growth which was magnified due to leveraging may now lead to contraction. It is not that the U.S. and Europe is simply going to wither. They have to under go medium term pain, austerity, strong fiscal prudence so that they can consolidate and start growing again.

This cannot happen over night and may take years. U.S. has better demographic advantages to bounce back viz-a-viz certain sections of Europe.

In fact many U.S. companies are in better financial health than U.S. economy and their market is also not restricted to U.S.That’s why  legend like John Bogle says that one can expect annualized return of around 7% during the next decade by investing in U.S. stocks; remember 7% returns is very good when long term yields from U.S. treasury is abysmally low and Fed wants to keep it that way.

The core of the problem is that banks and financial institutions with blind central banks forgot the basics in pursuit of growth and return without remembering the four letter word – risk.

Growth at any cost is the thought process of a cancer cell. It ultimately kills.

Though we may think all these situations are new, if you read history, especially financial history, excesses, shrinking and moderation keeps happening time and time again. It’s an endless cycle.

In my opinion, a strong dose of philosophy and history would help us to be better investors than what we learn in colleges. Though I’ve studied MBA- Finance at IFMR (which is really a good institution) and has completed CFP certification, whatever I’ve understood so far about investing and personal finance is more from legends and history. My natural inclination for philosophy also helps!

Before proceeding further, I want to quote from what Warren Buffet wrote to his shareholders in 1994. The message is as relevant today:

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise – none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.

Sentimentally, for short term, we are definitely coupled with world markets. Fundamentally, for long term, we are to a greater extent decoupled from rest of the world.

What western world is talking about their GDP growth for the next one decade, around 1% is actually a rounding off error as far as India is concerned. What I mean by rounding off error is the difference between various projections as to whether we will grow at 8% or 7% or 9%.

This year, due to monetary policy aimed at curtailing inflation even at the cost of growth, would marginally impact our overall growth. Inflation is the cruelest tax, especially on poor people and in my opinion RBI has done a good job (in the absence of any other tool) and everyone hopes the results would start showing before end of this financial year.

It took us nearly 60 years after independence to touch the GDP growth of $1 trillion. Whereas by 2020 this number is expected to increase by 4 to 5 times – a GDP of around $5 trillion.

The balance sheet size of banks inIndiais expected to increase by 10 times to touch $10 trillion in 2020.

When the economy grows at 8% or 9%, the nominal rate of growth would be 15% (assuming 6% inflation). When the broader economy itself grows at 15%, good businesses that are listed in stock markets would grow at a much better rate.

This is the kind of return that is possible in equity.

We can only work on our approach and attitude towards investing but can never control the markets. This need not disappoint you as prices tend to mirror the value in the long run.

Markets can test our patience, conviction and judgment to the hilt. But the reward is worth developing these traits.

The habit of investing regularly and for long term is capable of rewarding us extremely well. For any asset class, equity or debt or real estate, the time horizon of investment is extremely important for achieving the possible returns. If there is mismatch between the time horizon and the nature of asset; then it would be classic case of ‘sour grapes’.

Though it is difficult to predict; looks like flow of bad news may last for a while. Learn to de-link the investment process from the over flowing news. Bad news sells well and what sells would definitely be magnified.

There is a risk in every investment – equities, real estate, gold and debt.

Even safe investments carry the risk of erosion of capital due to inflation and taxes. Some one who is very rich can take this risk as even after the above erosion; the life style and financial goals can be met. Rest of us need to understand and take measured risks. The risk can be managed well if we stick to the time horizon for the investments chosen. Can risk be totally avoided? The answer is no. It can only be understood and managed.

There is a general belief  in India that real estate and gold are not subject to cycles and goes only in one direction.

How much ever one says, seeing and experiencing would only bring in belief. I think we would all be blessed with that belief some time in the current decade itself, especially in case of gold.

I repeat fear is good. It would ensure that we don’t stupid things with our money. Equally good are cousins of fear like caution, skepticism etc. Don’t fall prey to positive thinking messiahs and throw these traits into bin.

However when fear totally cripples you or derail you from the process of  well informed judgment and conviction; fear the fear.

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