Financial Lessons from The COVID Crisis

Some or the other part of the world has always been facing crisis in some form or other. There have been events in the past which have affected the whole world at the same time. COVID Crisis is however unique to have affected almost every human being in some form or the other. Strikingly it has also impacted everyone on the financial front irrespective of the nature of job, or strata of society to which the person belongs. The experience of last few months has just re-iterated the age-old fundamental principles of personal financial and wealth management. All the important aspects have been demonstrated in a relatively very small-time frame. Let us today discuss the financial lessons which the COVID crisis has reiterated.

Emergency Corpus for Difficult Times

Uncertainties of some form have always been part of our lives. Financial uncertainties are of greater concern to people who do not have an assured source of income. There can however be severe conditions which hit the employers paying capacity, including that of the sovereign government. The requirement of an emergency corpus therefore does not need greater emphasis. You must have at least six months of income as contingency fund. Further adequate fund to cater for about one year’s expenses can be kept in secure instruments with easy liquidity. 

Diversification of Assets

The classic interplay and correlation of different asset classes was very clear during the crisis. When equity crashed, the debt instruments outperformed. Gold soared to amazing heights in a short time frame. While Real property might not have shown much change, the Real Estate Investment Trusts (REIT) did fare well. Any sensible investor should be having a diversified portfolio. This will include a fair mix of Stocks, Mutual Funds, Gold, Real Estate and Debt Funds. If you had a diversified portfolio, then the shock of equity market crash would have been much lesser.

Market Cycles

Each sector of the economy has got its own cycle. The sub classes in Equity investments also show varying movements. It is generally believed that the large cap segment is least affected by any market crisis. The recent rally is however led by the Mid Cap and the Small Cap Segment. Investors who had adequate sub asset class diversification gained the most from this rally. It is certain that the trend will not remain the same, but the time and direction of change can also not be predicted. So, the best way remains to keep a proper Asset Mix with a diversified portfolio, and let the variations in return balance each other.

Investment Discipline during Crisis

Long term investment can tend to be boring. It is also very human to be overpowered by the emotions of Greed and Fear. We start thinking that we can time the market and always orchestrate our investments in a winning manner. The fact however is that nobody could ever do that. Empirical evidence also suggests that in the long run it is the disciplined investor who gains. When the stock markets crashed in Mar 2020, many investors pulled out their investments in the hope of getting back at further lower levels. Many stopped their Systematic Investment Plans (SIPs) in Mutual Funds. I had recommended then also to continue with the SIPs and not to redeem. All those who stayed invested have benefitted from the recent rally, and those who exited have learnt how difficult it is to time the market.

Reserves for Investment

When the markets crashed, the intelligent investors could sense opportunity. Anyone who invested during the fall is sitting on handsome gains now. But many felt that though they want to invest, they don’t have any more funds left. This highlights the need to always keep some investible reserves to make good of any opportunity that comes our way. Not all reserves should be committed in one go. Once committed, this reserve should be recreated at the earliest opportunity. This approach will make our desire to book profits more meaningful. It is also necessary to understand that the source of creating this reserve should never be a Loan.

Tactical Reallocation of Funds

Whenever the equity markets crash, the overall asset mix will get tilted in favour of the Debt allocation. It is also clear that markets will eventually come out of any crisis. Such events can also be used to carry out a rebalancing of the portfolio and do a tactical reallocation to shift funds from debt to equity. This will help us make best of the available opportunity and provide the much-needed investible reserves. One should however never temper with the funds earmarked for any pre-defined purpose for the next five years.

Need for Insurance

Insurance is the basic financial tool to mitigate risk. The market today offers a plethora of options to cater for diverse needs. The experience of last few months should be good enough to indicate the financial risks that we face in individual context. This could be related to medical aspects, credit issues, or employment and income related insurance.  

Repayment of Loans

Many people whose income was affected also faced the challenge of paying EMIs of loans. The problem was more pronounced in case of personal loans for discretionary expenditures. Loans taken for purchase of productive assets can still be managed by disposing the asset if required. We should therefore be very careful while taking personal loans to fund Lifestyle Expenses.

Recommendations

1. Always keep an Emergency Fund equal to at least six months of your income. Also try to maintain adequate funds to cater for one year of expenses in secure and easily cashable financial instruments.
   
   
2. Do not try to time the market. Continue with your investments during crisis period also.
   
   
3. Keep a diversified portfolio with adequate Asset Mix to even out the variation in returns.
   
   
4. Try to always keep some investible reserves to make use of any market crisis. Never take loan for investment in Financial Markets.
   
   
5. Assess your Risk and purchase an appropriate Insurance to cater for such contingencies.