Present tense, future uncertain


Emotions shouldn’t come in the way of accumulating money, even though there is no predicting the future

As humans, we prefer happiness in the present to more happiness in the future. Add to this the emotional impact of COVID-19 and we have an issue at hand. Should we think long term and plan our investments accordingly even if unforeseen calamities can change our lives? In this article, we discuss why despite pandemics, natural disasters and financial crises, you should invest, preferably through systematic investment plans (SIPs), provided you have steady, active income. We also discuss how you should determine the amount to invest through SIPs.

Future uncertain

COVID-19 has shown us how swiftly our world can change. It is, therefore, not surprising that this pandemic has only accentuated our present bias. Why cut current lifestyle and save when the future is so uncertain?

Clearly, such argument can be self-defeating. True, a life-threatening virus attack or a loss of a family member would hurt. But such incidents are unlikely to make your responsibilities go away. You still have to fund your child’s college education, pay your outstanding mortgage and accumulate money for your retirement, among other goals.

While a philosophy of ‘living each day’ can be useful for personal growth, it cannot be extended to achieving your investment goals. You should, therefore, have an automatic investment process to ensure that your emotions do not hinder your requirement to accumulate money, even though the future is uncertain. Hence, the need for SIPs.

But, how should you fix the amount for your SIPs? Often, most individuals set up SIPs based on the amount they can comfortably save each month. Unfortunately, this system cannot work well in the current world. Online shopping, credit cards and electronic money have made it easy for us to spend more than we should. You have to, therefore, set side your monthly savings first and then spend the rest of your income.

SIP amount

You can determine your investment in SIPs by applying the following steps:

First, estimate the amount you want to accumulate at the end of the time horizon for a life goal (say ₹1 crore at the end of 10 years).

Second, state the shortfall that you are willing to take at the end of the time horizon for the goal. Suppose, you are willing to take a shortfall of 15%, an amount you believe can be bridged through other means.

Third, assume an expected post-tax return on equity and bonds. We have assumed 3.85% for bonds and 10.8% for equity.

Fourth, determine an equity multiplier. This is one divided by the maximum loss that equity markets can suffer in a year (say, 50%). So, the multiplier is 2. Finally, apply the multiplier on the shortfall you are willing to take. This will give you the accumulated value of your equity investments after 10 years, provided the investments earn the expected return. This amount is ₹30 lakh, which is 15 lakh times 2.

Now, determine the monthly investment that will accumulate to ₹30 lakh in 10 years at 10.8% compounded annually. This is your required investment in equity SIP. Similarly, determine the amount to invest in a recurring deposit to accumulate ₹70 lakh.

Conclusion

What about the time when your cash flow is stressed or you fear the market has risen too much too soon? You can reduce your equity SIP for a while because you have allowed for a 15% shortfall in the end-of-the-horizon portfolio value.

You can set up your SIP on an ETF if your brokerage firm offers such facility. You can also pause such SIP if you have to. Alternatively, if you invest in an index fund or active funds, you can avail of the pause-SIP facility that some asset management firms offer.

The present is, indeed, tense and the future uncertain. Invest, nevertheless, because you have to.

(The writer offers training programmes for individuals to manage their personal investments)



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