Financial Lessons From The Pandemic

Financial Lessons From The Pandemic

While the need for basic hygiene and social distancing is one big lesson that the global pandemic of the corona virus has taught us, the drastic movements in the equity and other markets have also been tutorials of a kind that will help us chart out a sound personal finance plan for the future 

The spread of the corona virus globally will certainly leave a deep impact in the lives of individuals across the world. This will not only affect them physically in terms of a drastic change in lifestyle and behaviour but also financially. The financial impact can, in fact, be gauged by the loss to equity investors. Since the start of the year, the frontline equity indices have been down by 25.74 per cent. Not just that but even the mid-cap and small-cap indices have witnessed a similar fall. Such a steep downward slide has emboldened mutual fund investors, who are not pulling out money from their equities.

Rather, they are infusing more money in equity-dedicated mutual funds. This shows the immediate change in the mindset of investors. That said, to take advantage of this nose-dive in the market, people are scrapping their other investments such as bank fixed deposits or recurring deposits to invest in equity markets. Even whatever surplus money is available is now being diverted towards investment in equity. Nevertheless, while doing so, most investors are not taking a pause to think whether this kind of hasty investment in equities is making them compromise on their actual investment objectives.

Therefore, we suggest that you sit back a bit and give a thought to whether you need this money in the short or long term. If you don’t need the money for say five to seven years from now then go ahead and invest it in equities. But if you have some short-term financial objectives lined up, stay away from equity and consider money market funds and ultra-short duration funds for the same. Meanwhile, the pandemic has definitely taught us a few important personal finance lessons. Let us see what these are:

Value of Emergency Fund
Many a times, people ignore the advice given by financial planners for building and reviewing an emergency fund. In fact, a majority of people are keenly focused towards investing to earn handsome returns, thereby ignoring this basic step in personal finance. The nation has been in a lockdown phase for more nearly a month now with no indication of a decrease in the virus cases or a flattening of the curve. And even when the lockdown ends, it will take some time for the situation to return to normal, which will probably happen in phases. We are already hearing about layoffs and salary cuts.

Not just that, most businesses are also staring at huge losses. Many companies have asked their employees to proceed on unpaid leave. All such measures lead to a blockage of regular source of income. Given the seriousness of the situation, the government has allowed for withdrawal of 75 per cent of the funds in an individual’s Employee Provident Fund (EPF) account. In such a scenario, the lack of an emergency fund can lead to a critical shortage in cash required for day-to-day expenses. Withdrawing from an EPF account means that you would be compromising with your retirement planning.

If you are self-employed or a business owner then you would need to break your other investments that may have been dedicated towards your other financial needs. Therefore, to avoid reaching such a stage, it is important to protect yourself from any temporary loss of income with the help of an emergency fund. Having three to six months of your fixed expenses, which should also include your outgo towards insurance premium, monthly instalments and SIPs, as an emergency fund is ideal. However, on a conservative basis it would be better to have 12 months of fixed expenses as your emergency fund. If you are a business owner then have at least 12-18 months of emergency funds in place. This would also help you in times when your business is moving through a rough patch.

Health Insurance
The basic insurance that one must have is that of life and health. Life insurance would help you to secure the lives of your loved ones even in your absence. Health insurance helps you protect you and your family financially during hospitalisation. Therefore, having both these covers is the bare minimum that you should have. Assume a situation when you or someone in your family gets infected with the corona virus and has to be admitted to a hospital. At such a time, it is your health insurance policy that would provide the necessary financial protection so that you don’t have to compromise your other investments. The same is the case with a life insurance policy which can take care of a deceased person’s dependents.

Asset Allocation and Re-Balancing
When it comes to investing, it is important to adopt an asset allocation and re-balancing strategy since it helps contain risk in the long run. Asset allocation is nothing but an investment strategy that implies investing in different asset classes to contain the risk involved in investing in a single asset. Basically, asset allocation divides risk by dividing your investments among different asset classes that are most probably not correlated to each other. Re-balancing is nothing but restoring your target asset allocation. Let us understand it with the help of an example.

As a part of this case study, we have considered the S & P BSE Sensex index to be a representative of the equity asset class and the S & P BSE 10-Year Sovereign Bond index of debt and gold for gold prices from the year 2000 to 2019. Let us assume that you invest Rs 1 lakh by equally dividing it among equity, debt and gold. This will bring your asset allocation to 33.33 per cent equity, 33.33 per cent debt and 33.33 per cent gold.

The above graph clearly shows that if you would have invested in a portfolio then it would have proved to be better than investing in individual assets. Note that the portfolio must be re-balanced annually by returning to its target asset allocation of 33.33 per cent in equity, 33.33 per cent in debt and 33.33 per cent in gold. Also, from the above graph you might have noticed that it is unrealistic to expect returns in the short run. Therefore, for the short term, invest in debt and for medium and long-term, invest in a mix of equity, debt and gold.

Conclusion
It is rightly said that experience is the best tutor. In the course of this pandemic, many an investor would have gained insights about what works as an investment and what does not. There may be a few regrets too about having parked your funds in the wrong asset classes. Nevertheless, when things settle down, do consider visiting your financial planner to get your financial plan updated. If you do not have a financial plan, get one. The lessons learned over the past one month or so will help us streamline our personal finance strategy in the future.

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