Think before making your investments, not later

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We are going through challenging times. There is correction in the equity market, defaults in debt funds and even issues with certain banks. Many investors are wondering what is ‘safe.’ Nothing has changed fundamentally in our economy or the financial markets. Due to COVID-19, economic growth has been impacted, but we will come back over a period of time. There is no reason to suspect something is going wrong with investments in general. To put the current situation in perspective: the equity market, in particular, the global markets, pre-COVID-19, had a significant run up.

Also read: COVID-19 | Coronavirus infects global markets, investors exit equities

There was a lot of surplus liquidity floating around (there still is) and that pushed up prices in equity markets in advanced economies. In India, the equity market had moved up but more at the index level (Nifty, Sensex) and in large cap stocks. The broad market, taking all listed stocks into consideration, had not moved up as much. After the pandemic, the sharp correction has been inevitable as advanced economies are staring at a recession.

With markets being interlinked, the correction had to happen in India as well.

The defaults in debt funds happened due to multiple reasons, the major one being the cleaning up of the system. Earlier, the practice of ever-greening was rampant i.e. granting one more loan so that an existing loan does not go bad. With stricter regulations, including the IBC, some companies were taken to the NCLT. The risk in debt in still there as the economy has slowed down but it is not so alarming as to make one exit all one’s debt investments. For now, due to the challenging situation, the government is supportive and going slow on entrepreneurs.

Issues in banks are specific to a few lenders. The macro issue due to higher NPAs and consequent losses have been addressed by the infusion of capital by the government. Certain banks had supressed NPA information earlier, which is coming to light now, leading to issues.

Also read | COVID-19 outbreak to hit global growth but will have limited impact on India: RBI Governor

Concerns due to the reasons mentioned above and their impact on your investments are natural. It is in human nature to make an investment without caring about risk factors. Afterwards, when something breaks out, people tend to over-react to the risks by moving out of the investment at the wrong time (when prices are low) or trying to pin the blame on somebody.

What should you do?

First, decide which asset categories you want to invest in. The investment avenues are equity stocks, debt i.e. bonds and, to a limited extent, other investments such as gold and real estate. You may invest either directly i.e. purchase shares or bonds, or, do it through a vehicle such as mutual funds. Every investment avenue has its own worth, return potential and risk factors.

You should understand these before you make the investment so that you know what you are getting into and will not be taken by surprise later on. If you are investing through an adviser, ask questions and understand the downside, i.e. potential correction such as the one happening in the equity market now.

If you are managing investments yourself, you have to do the research and convince yourself about what you are getting into. [About] 30% correction in the equity market is not unheard of in history; the question is whether you are aware of it and mentally prepared for it. Defaults in bonds is a potential risk; what is happening over the last one-and-half years is on the higher side and unnerving investors.

Once you decide which asset you want to invest in, decide how much to invest and into which category. Certain investments have a higher potential for uneven returns such as equity. If you have a longer period to stay invested in, you can cross over the volatile phases and reap the returns. It would be a wrong decision to exit from equity at this juncture, just because prices have come down. Rather, lower prices are a reason to buy more.

Growth potential remains

The growth potential of the Indian economy remains the same, only that there is a dull phase till we come back from the lockdown. In assets such as equity, you should keep as much as you can for a long period of time, without worrying about day-to-day returns. For debt investments, which is preferably done through the mutual fund route, there are risks of volatility and default.

You have to choose the fund category accordingly, so that you understand the risk-return profile of that fund. Your allocation to debt funds should be as much as you can keep for the appropriate period, which is less than equities.

Gold, as an asset, does not produce anything; its value increases in times of uncertainty like war or a pandemic. Hence, the allocation of your funds to gold should be of a lower proportion. Your investments should be productive, not just depending on uncertainties to prolong.

If you raise the concerns before making the investments, you can save yourself the hassles of agony on negative returns in a particular phase or defaults in debt, and sleep peacefully.

The other aspect you have to take care of is the communication gap between you and your services provider.

You are investing your hard-earned money and you have to be clear about what you are getting into. For this, you have to ask the relevant questions and convince yourself: why it is suitable for you; how long you have to stay invested; and what the potential for negative surprises is. The only reason to exit an investment prematurely is if the nature of the investment itself is changing, which is not the case now.

(The author is founder, wiseinvestor.in )

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