While the child can find employment in the future and earn an income, parents do not have that luxury if they exhaust their assets

A family that pays together, stays together, but the key is to set the limits

When helping out children, parents must set the limits in terms of money and time

Many parents are financially supporting their adult children in a meaningful way in the aftermath of the covid-19 pandemic that has resulted in rampant job losses, pay cuts and professional uncertainty.

Take the case of X, whose son had quit his job to start an organic farming business two years ago. The pandemic disrupted the business’s demand, supply and distribution chains, leaving the son struggling to meet his family’s routine expenses. Or the story of Y, whose son could not meet his daughter’s undergraduate fees for a foreign university because of a huge dip in his portfolio value. Lastly, Z, whose lawyer son was suddenly diagnosed with brain cancer, leaving the son struggling to earn an income to meet his instalments.

In all the above situations, the parents stepped forward to bail out their children with financial support. X created a trust fund, which provided the son’s family a monthly income that met their routine expenses. The son was, therefore, able to focus on bringing his business back on track, knowing that his parents were meeting his family’s basic needs. Y offered his son an interest-free loan for three years to pay the undergraduate fees so he would not need to redeem his portfolio at a loss. Z shook off the loan collection leeches by paying down the home loan entirely and securing the home papers for his son.

But parents must wear their safety belts first before helping others. If their assistance towards their children negatively impacts their financial independence or goals, they must desist from offering such support. While the child can find employment in the future and earn an income, parents do not have that luxury if they exhaust their assets, leaving them eventually dependent on their children.

Hence, even if parents offer financial assistance, they must structure a broad framework of such financial support and set limits in terms of money, time or emotional involvement. This framework is crucial to establish expectations, else it may lead to unhealthy dependence or friction on both sides.

Generally, the financial assistance offered can be of four types: income, expense, asset and liability.

Income: Income support comes by way of providing a fixed inflow each month. One of my clients redirected her rental income to her daughter. Other sources of income may be in the form of trusts, dividend from stocks or interest from bonds and deposits, or systematic withdrawal plans (SWPs) from mutual funds.

Expense: Parents can take over a part of the children’s expense, such as equated monthly instalments (EMIs), rent, school fees or routine expenses. It is important to ensure that the expense commitment is fixed and predetermined so that expense spikes do not cause steep outflows on certain months or extend beyond the decided time limit.

Assets: Parents may decide to fund an asset, such as a car or a house, partially or fully. In some instances, parents may find it prudent to gift a property during their lifetimes rather than bequeath it after their death. If parents have the financial wherewithal to transfer wealth during their lifetimes, it may be more beneficial for their children now, than to leave behind a large inheritance when the need is not so dire. In fact, transfer of wealth during the parents’ lifetime offers them immense satisfaction when they see that the money is being put to good use, such as educating a grandchild, buying an asset, or closing a loan. However, such transfers must not materially affect the financial independence or lifestyle of the parent.

Liabilities: Though taking over a liability is not advisable for retirees, parents can choose to pay down a child’s liability, such as a credit card bill for the month, or car and home loans, if their finances are healthy. They may also choose to pay down a loan entirely or partly instead. But parents must refrain from taking on loans as a co-signee, since the responsibility for repaying the loan then shifts to them, at least partially.

Financial advisers play an integral role in deciding whether elders have the wherewithal to support their children. They can project expenses into the future and ensure the existing corpus is able to weather inflation, taxes, market disruptions and unplanned expenses. Such calculations must be arrived at after factoring a very conservative return on assets, or in some instances, even writing off a part of their assets. After leaving an adequate buffer, any remaining surplus can be used to help their children financially. Advisers can also act as an objective third party, highlight the consequences of certain financial decisions on both parties, intervene between the child and parent, and enforce discipline when financial boundaries are crossed.

It is natural for parents to help their children in distress just as children would want to do so for their parents. This support is what binds families together, and strengthens and nurtures relationships. Parents need to walk the fine line between supporting an otherwise hardworking child who has fallen into bad times; and supporting an entitled child and creating an ongoing dependency. If it is the former and you have put on your oxygen mask, go ahead and strap it on for your child too.

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Owning portfolios most adaptable to change makes more sense in today’s world

People change. Ideas change, dreams change, relationships change, preferences change. These are internal changes, in the way one thinks about life and about the role of money in it. And while all this happens, the external world changes. Circumstances change, markets change, abilities change, employment and employability change, health and longevity change.

As we enter the new year with hope and optimism, we leave a year that has given us a new understanding of the scope and scale of change that can occur. We all did whatever we could to emerge successfully on the other side of the pandemic. Families worked hard to ensure that each family member had the resources and support to withstand the pandemic’s challenges. Companies re-evaluated many long-standing assumptions about their business environment and developed new ways of operating. Governments prioritized the today over the tomorrow with stimulus packages, and many struggled with the trade-off between the lives and livelihoods of its citizens.

Change is an interesting thing, like spice in your soup. Too much of it ruins the soup and makes it unpalatable, but the complete absence of it is intolerable. Like the film Groundhog Day, whose protagonist wakes up each day to encounter the exact same set of events as the day before. To some people well into a comfortable retirement, this may be familiar.

Unlike spice in your soup, however, change in your life is often outside your control. Things happen, and you respond. Darwin identified long ago that “it is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change”. How do you build a portfolio that is most adaptable to change? I would argue you would focus on building three things that any great general of an army would do—strength, agility and resilience.

The stronger army generally wins. Stories of weaker armies emerging victorious are remarkable because they are rare. Further, generally the larger army is the stronger army. Portfolios are similar in that the larger they are, the better capacity they have to weather change. People who have become wealthy in their lifetime often refer to the freedom that their wealth gives them, the freedom to spend knowing that they are unlikely to make a dent to their wealth, the freedom to take on new risks that they may not have considered before. This freedom originates from an ability to incur some losses without materially impacting their sense of well-being, their independence. A habit of prudence and discipline regarding one’s expenditure is the most proactive way to build a large portfolio, so that the money saved becomes available when needed.

Agility gives one the ability to respond quickly to change. In the face of adversity, an army that can redeploy soldiers and resources quickly and efficiently in response to a new strategic thrust is more likely to succeed. In a portfolio this is best assessed by the liquidity of its constituents. In other words, when one needs the money, how long will it take to convert the asset into cash in the bank? Also, will your asset retain its value even if you are in a hurry to monetize it, or will it surrender some of its value as a haircut? We often see such a haircut in distress sales, whether these be real assets or financial assets. One can assess liquidity by the depth of markets in which these assets are transacted. While markets like those for gilts or large-cap stocks treat sellers equally, whether in a hurry or not, markets for small-caps, antiques or below-investment-grade credits are likely to penalize those in a hurry. One can retain an agile portfolio by ensuring that it is invested in predominantly liquid assets.

Resilience gives one the ability to bounce back when struck down. An army with multiple skill sets to draw upon, depending on the context, is better able to withstand initial setbacks and still emerge victorious. In a portfolio, this is best achieved by using asset allocation to achieve balance and diversification. The ability to achieve lower levels of overall risk by including assets in the portfolio that have low correlation is well-documented. The inclusion of gold and debt may not set your portfolio on fire but will provide a cushioning effect during sharp corrections. Similarly, through geographical diversification, one can reduce the overall risk level of the portfolio without sacrificing much return.

The fact that “black swans” are becoming more frequent is a testament to the fact that we live in very interesting times. Owning portfolios most adaptable to change will ensure you can enjoy the excitement rather than be defeated by it.

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Determine the result, ascertain its cause, assess the momentum to better predict performance

For all the talk, the pretence of knowledge, even the condescension she had got from her husband in terms of investment skill, she had beaten his pants off. Her investment had grown by 28%, whereas her husband had lost money. Here is the interesting part. Both had invested equal amounts of money and in the same scheme. The only difference was that the husband invested in February this year, whereas the wife invested in April. The husband had caught the crest of the wave, whereas the wife had caught the trough that followed a few months later. Was that skill or luck?

At the best of times, and armed with sophisticated attribution models, separating luck from skill in investment performance is difficult. Anyone who has invested across market cycles will know that some decisions that were backed by robust and thorough analysis suffered in comparison to other decisions that were made with the most cursory analysis. Having tracked the performance of mutual fund schemes and fund managers closely for 15 years, we have seen superstar fund managers from one era scrape the bottom of the barrel in another and vice-versa.

Yet, any endeavour of investing over the long term would be significantly hampered without an ability to analyze performance and draw the right conclusions. Here are some of the obvious questions that need to be addressed. First, the result—how well did your investment decisions fare? Second, the cause—how much of the result can be attributed to luck and how much to skill? Third, the “so what”—given the past, what should you do going forward? Let us look at each of these.

The result can be described in a few different ways. First, in rupees—how much money did you gain or lose? Second, as a percentage of the amount invested, or absolute return. Third, as a percentage after adjusting for time invested. Surely, a 20% return in one year is better than a 20% return in three years, right? This measure is usually called annualized return. Fourth, as a comparison to a benchmark. If one made 18% return where the benchmark made 20%, is that better than another making 16% where the benchmark made only 14%? Another way of looking at the same thing is to adjust the return for the amount of risk taken to achieve that return, something we refer to as the Greek letter alpha. We all need some measure of compensation for taking additional risk, often known as risk premium.

These measures do sound a bit like the blind men and the elephant, where they all came up with different assessments. Yet, people have many questions regarding their investments, and each measure above answers a different question. If you are looking to compare investment performance, using alpha and comparing against the benchmark are useful places to begin.

The cause is trickier, because here one needs to separate luck from skill. Timing is one of the reasons that can drive improper conclusions, as we have already seen. Further, when one is comparing two investment experiences, it is important to ensure it is an “apples to apples” comparison. Comparisons between fundamentally different instruments that are likely to behave differently are flawed, such as a mutual fund with a unit-linked insurance plan (Ulip), a hybrid scheme with an equity scheme, or a large-cap with a mid-cap. The third is to distinguish between consistency and “flash-in-the-pan” outcomes. Superior performance must be repeatable to be claimed as a skillset.

Finally, the “so-what”. To what extent can our conclusions from these comparisons be extended into the future? When is change necessary? If you are happy with the result, should you stay the course? If your results aren’t great, do you need to make changes? If our goal is to predict what will deliver superior returns in the year ahead, let us reflect on the inputs. While there are many factors, here are some to consider. The investor’s skill, whether it is regarding instrument selection, asset allocation or execution is likely to persist. The processes followed, whether they be research, investment or risk management, are also contributors. However, it is important to assess whether the investment environment has changed. If so, what worked in the past may not work in the future. Winners in a bull market are often different from winners in a flat market.

I recommend the above three-step process—determine the result, ascertain its cause, assess its momentum—as a way to achieve greater predictability in investment performance. At the very least, it will establish a lingua franca for its discussion.

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• If most of their money is invested in fixed-income securities such as bank deposits and bonds, over time, the returns on these will struggle to beat inflation as rates fall
• The periodic increase and decrease in interest rates is a key monetary policy measure

My 70-year old aunt is anguished every time the Reserve Bank of India (RBI) announces a rate cut. “I used to get 14% interest on my fixed deposits (FDs) at one time, and now I barely get 7%.” It is a common lament among retirees whose income ebbs with a fall in interest rates.

If most of their money is invested in fixed-income securities such as bank deposits and bonds, over time, the returns on these will struggle to beat inflation as rates fall. Retirees depend on the returns from a fixed corpus to fund expenses. If interest rates fall, they increase the draw-down from the corpus to meet expenses. If the draw-down rate is high, they run the risk of exhausting assets before their lifetimes. Alternately, to stretch their corpus, they reduce expenses, which can affect their quality of life.

The periodic increase and decrease in interest rates is a key monetary policy measure. Typically, interest rates are increased to curtail inflation and vice-versa. The current low rates are a measure to encourage borrowing, spur business growth and increase consumer spending. However, sustained low interest rates hurt retirees the most, since their capacity to earn fresh income is limited. Low returns on fixed-income instruments is akin to a pay cut for senior citizens.

As our economy develops, we will see more rate cuts. Many European countries have negative rates and several developed countries are at sub-3% rates. But one must also keep in mind that even though interest rates will continue to fall in the future, so will inflation. The high inflation rates seen in the past are unlikely to play out in the future. Hence, the real return on our investment (the difference between nominal return and inflation) may not be affected to the extent of the fall in interest rates.

Here’s how to make the best of a low-interest environment.

1. If you are a business owner, you may consider increasing your borrowing since loans will now come cheaper. You can even ladder your loans by borrowing at the current low levels to pay off older, higher-interest loans. As a retail investor, you can avail cheap property, car or personal loans. You can also refinance existing, expensive loans to cheaper ones.
2. Invest in alternate assets such as gold. Gold, typically, does well when borrowing cost is low, money supply is high, the economic outlook is uncertain, and equity market is volatile. However, be wary of investing in gold when the prices are already inflated. Have systematic investment in gold across the year, so you catch the low prices along with the high. Having at least 10% allocation to gold helps manage portfolio volatility better.
3. It is important to allocate a part of your portfolio to equity to beat inflation and taxation over the years. However, increased equity exposure could make the portfolio volatile in the short term. High volatility may be palatable for someone young, who has higher risk-taking and income-generating ability, but could make an older, risk-averse person quite nervous. Working with an adviser will help determine an equity allocation that is consistent with your risk appetite and future cash flows. Even conservative organizations like the Employees’ Provident Fund Organisation are now allocating a part of their portfolio to equity to beat inflation and generate higher long-term returns.
4. Interest on FDs attract tax slabs, which can be steep if you are in the highest tax bracket. However, investing a part of your portfolio in safe, high credit-quality, short-term debt funds can offer better tax-adjusted returns. If you redeem after three years from debt funds, long-term capital gains set in, which are taxed at 20% after indexation. Short-term gains are taxed at marginal rate.
5. A rupee saved is a rupee earned. If you need to generate regular income, consider systematic withdrawal plans (SWPs) from debt funds, which are more tax-efficient than FDs. If you invested ₹10 lakh in a 7% FD, you’ll earn an interest of ₹70,000 on which you would pay tax of about ₹21,000 (assuming you were in the 30% tax slab). If you invested the same amount in a debt fund, which also grew at 7% and you withdrew ₹70,000 after a year, your capital gains may be less than ₹5,000, on which you will pay a tax of ₹1,500, for the same tax slab. This is because the withdrawal in a debt fund is a combination of the principal and the gains, which reduces your tax bill, as opposed to the entire gains.

“That Senior-citizen Welfare Plan you recommended has saved me a heap of money in taxes!” exclaimed my aunt, who had just filed her returns last week. I briefly considered correcting her abbreviation of SWP, but her understanding of it was spot on. I smiled and left it at that.

The post It doesn’t always pay to bank on fixed deposit appeared first on PeakAlpha.

How long can their existing assets carry them? And if it does not stretch until the end of their lifetimes, what can they do to ensure they have money at the end of their lives and not life at the end of their money.

Increasing income and savings is crucial for those who don’t have adequate assets.

Can’t I retire today?” asked a despondent X who had just been told by his employer that his salary would be indefinitely reduced by half the following month onwards. He was convinced he may lose his job soon and had lost all motivation to work. The covid-19 pandemic has caused many to feel insecure about their employment. For those who have already lost their jobs, finding new opportunities look daunting. So, the most common question I get asked by my clients is if they could be financially independent if they did not generate any income henceforth.

How long can their existing assets carry them? And if it does not stretch until the end of their lifetimes, what can they do to ensure they have money at the end of their lives and not life at the end of their money. Essentially, there are four financial planning levers that you can tweak today to influence future outcomes.

Increase income

If you can increase income by moving to a new job, negotiating a raise or supplementing your existing income, you provide yourself the ability to save more. Enhanced savings that are invested in line with your asset allocation enable you to reach your target retirement corpus sooner and, hence, retire faster. If you are already retired, even a part-time job with a small income can support your expenses. This additional income can then reduce the monthly draw down from your portfolio, allowing the retirement corpus to grow and compound for a longer period.

Increasing income or enhancing savings is especially crucial for those who have not created adequate assets and retirement is a mere touching distance away. However, it is also true that if you are at this stage of your life, you probably have the highest propensity to save. You may be at the peak of your income-generating capacity, and major expenses such as children’s education and home loans may have already been paid down. It is time now to hunker down and focus on building that retirement portfolio that will allow you to live your present lifestyle well into your retirement. You may not want to holiday in Nandi Hills after retirement when you enjoy the view from Mount Etna a lot more.

Reduce expenses

If increasing income looks unlikely in the current circumstances, you can reduce expenses to boost monthly surplus. This way, you increase the amount you save and invest each month and stay on track towards your retirement goals. However, knowing how much to invest, the tenure and return on investment is crucial to building your nest-egg. True that you are sacrificing current consumption for future gratification, but you will be thankful, especially if you are 70 and staring at a bank balance that barely funds a year of expense.

Extend working years

Most of you do not like the sound of it. It is also an option that you have the least control over. What if you are unwell and are unable to work? Or your employer does not postpone your retirement? Or you are unable to find suitable work after you retire?

If you have gotten off to a late start with respect to your investments, you may not have much choice but to pursue this option. Most of us should plan for a life expectancy of 90 years. If we retire at 50, we need to have saved enough to last us for another four decades. If we can push our retirement away by a few years, we allow our money to grow and compound for a longer time. The corpus will also need to fund expenses for a shorter retirement.

Reset asset allocation

Each of us has a specific allocation between safety and growth in our portfolios that enables us to reach our goals in the most efficient manner. It could be 20:80 equity to debt for some or 80:20 for others. If all the above levers are not viable to build your nest-egg in time for retirement, do consider tweaking your asset allocation to make it more aggressive. Of course, increasing the proportion of equity in the portfolio will render it very volatile in the short term. However, over time it helps compound your money faster. This is my least preferred lever, but if you have no other option, go for it. Ensure you have adequate money to meet short-term requirements, so you don’t need to dip into the equity portfolio to meet expenses during the accumulation years.

The good thing about structured financial planning is that it lets you peep into your future. If you find the future looking bleak, tweak one or more of these levers today and achieve your desired outcome for the future. Next time you want your fortune predicted, don’t go to an astrologer, make an appointment with a financial planner instead.

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“To redeem or not to redeem is the question”

Check if redeeming can cause further losses in terms of exit loads or taxability

My seven-year old golden retriever, Leo, is a rather feisty dog. Walking him each morning is an exercise in physical and mental endurance. He constantly yanks his 30-kg frame on the harness, lunges at unsuspecting walkers in the hope of a friendly pat, flips out when he spots a feline or bovine, and marks his territory with dogged determination on every parked vehicle. The 45-minute walk from my home to the army grounds and back is all the callisthenics I need for the day. While everyone notices his rambunctious behaviour, few know that Leo has an uncanny sense of direction. No matter how far I walk him or through which unfamiliar route I take him, he will always lead me back home safely. In the process, I have become fitter too, just keeping up with his boundless energy.

Leo’s conduct is akin to how the market behaves in the short term. It stalls, lunges, plunges and behaves erratically most of the time. But over time, it leads you to your destination and delivers healthy returns. All you need is resilience and patience.

The job of a financial planner is to establish a strong visual for the future and then guide the client in achieving that vision in the most efficient manner. In this journey, there will be several instances of planner-client dissatisfaction because the journey to achieving the end goal is fraught with pitfalls and negative portfolio returns in the short term. Long-term goals that are several years away cannot be achieved unless the short-term pain is experienced. It is almost a rite of passage.

However, events like covid-19 cause clients to forget their long-term plans and make irrational decisions based on market noise. If you are paranoid about your portfolio and feel the urge to exit because of the market corrections, ask yourself these questions:

One, has only your portfolio corrected or has everyone’s? Most equity portfolios have eroded anywhere in the range of 10-30% depending on when you invested. Hence, this is a systemic risk, not unsystemic risk that only you are exposed to. Systemic risks are easier to overcome since they are usually addressed by regulators, government and central banks.

Two, did your portfolio fall steeper than the markets? This is unlikely if your portfolio has the right allocation between growth and safety. If your portfolio had only 50% allocation to equity, your overall dip will not be 30%, but far less.

Three, is all your money invested in equity? If so, you have a problem. You must set aside a part of your portfolio in safe assets even if you need to redeem now.

Four, do you have enough money to deal with short-term contingencies such as a job loss or pay cuts? If so, do not redeem from your equity portfolio. Use the money in the savings bank or liquid funds to deal with the contingency. If not, redeem from those equity assets with minimum tax impact and exit loads.

Five, would redeeming from your equity portfolio sacrifice a long-term return of 10% for a safer debt investment that has a post-tax return of 4-5%? Would you, thereby, jeopardize an otherwise inflation-beating portfolio by your actions? If yes, do not redeem.

Six, would redeeming the portfolio cause further losses on account of exit loads or taxes? If so, refrain from redeeming.

Seven, is a short-term goal approaching soon? If you have money in safe assets, redeem from there. If not, redeem from equity and secure the money.

Eight, what is your best-case scenario? If it is one where you hold on to your job, meet short-term goals comfortably, and continue your investments to meet your long-term goals, then stay true to your original investment plan and do not redeem.

Nine, what is your worst-case scenario? If you were to lose your job and have no income for some months, determine if you can still meet expenses comfortably from your contingency fund. If not, then liquidity is key, and you may need to redeem from equity to meet expenses.

Ten, have you covered your health and life risks adequately? If not, do so right away, so you are not forced to redeem at distress or loss.

Once you are clear about how you will approach the above situations, you will make the right decisions now and for the future.

One of the biggest challenges for investors is closing the gap between their own portfolio returns and the fund or market returns. Often market returns are higher than investor returns because of human behaviour. We end up investing when the markets are high and pulling out when they are low. We focus on short-term performance and forego long-term gains. Above all, we do not practice efficient asset allocation and portfolio rebalancing. Efficient asset allocation requires staying away from behavioural biases of greed and fear. And, WhatsApp forwards.

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Rarely do we come across such sharp corrections in such a short span of time

In the past few weeks, we have witnessed bizarre swings in the stock markets. Most global markets have fallen between 10% and 30%. We can’t help but feel a sense of déjà vu, because this steep fall is reminiscent of the market crash of 2008. On 13 March, the Sensex oscillated from -10% to 10% in a matter of hours. All this carnage is attributed to the pint-sized covid-19, which is bringing the world’s largest economies to its knees. So, what should investors do in situations such as these, which noted economist Nissim Taleb famously called “Black Swan” events?

If I had to sum up my answer, it would be, “Buy low or lie low”. If your portfolio is underexposed to equity, buy at these attractive valuations to lower your average cost. If your portfolio has the required allocation to equity, then do nothing. Whatever you do, don’t sell now. That is easy to say and hard to do when you see your portfolio dip sharply. But bear markets are followed by bull markets. Usually, the sharper the correction, the sharper the recovery. Even in 2008, those who stuck around were the ones who were rewarded handsomely because the market rebounded far more than it fell.

It is precisely in situations like these that one must ask oneself: If my average returns in equity thus far have been 8-10% and the market has corrected by 25-30%, do I have the opportunity to increase my average return to 12% or more? In most cases, the answer is yes. If you have time on your side and your major goals are decades away, then the best thing to do is to lower your average cost by continuing your SIPs or investing a lump sum via systematic transfer plans. What happens to the markets this week or the next month or the next year will become irrelevant then.

You have invested in equity because of the high returns. You are aware that high returns come with high risks, and that the risk goes away with time. If you hold high-quality stocks or equity funds, you must hold your faith too. If you panic and exit, you may miss out on the rewards that await others who stuck around.

Fear and greed are the two most powerful emotions that compel us to sell when the markets are low and buy when they are high. Investors must bear in mind that having the right asset allocation is key in moments such as these. Having cash reserves or risk-free assets help you tide through market volatilities. However, if an imminent goal is approaching, and you have not moved the assets required to secure that goal to safer assets, you may find yourself in a bit of a spot.

Some sectors are more affected than others. Though the economy will slow down and eventually recover, you may find yourself in a situation where you may be furloughed. Stow away some cash these next few months and give yourself the runway to tide through at least a year of expenses. If you don’t do this, you may be forced to sell part of your equity portfolio at a loss to fund expenses.

Next, ensure you have adequate life and health cover. If you fall sick because of this virus or any other illness and you don’t have either corporate or private medical cover, you will be cleaning out your portfolio at the worst time.

Simplify your portfolio. The more complex a product is, the less you would understand it. Diversified mutual funds are a good way forward. They offer transparency, spread out your risk and let you invest systematically. Beef up your knowledge of these investments and you will be more in control of your money.

Remember that markets have crashed more than 10% in a matter of days about two dozen times in the last decade or so. Each of those crashes was followed by a rebound. Sometimes the rebound occurred in months, sometimes in a few years. If you wait for the rebound, you have already missed the opportunity.

A market meltdown is fraught with fear but it is also filled with opportunity. Rarely do we come across such sharp corrections in such a short span of time. No one knows how long the uncertainty will continue, nor do we know when the market will bottom out. So, the best thing to do is to stay true to your long-term goals. Be the master of your destiny and you will be better placed to control the outcome instead of letting fear control the outcome.

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How to protect the interests of elders suffering from cognitive disorders

Encourage the elder to appoint a trusted person who can help her take money decisions

I received a distressed call from one of my clients recently. The client’s mother was accusing her of stealing her money and wanted the daughter to move out of their family home. The mother is also my client and, hence, the daughter was seeking my intervention in resolving this unpleasant situation.

The mother, X, had been suffering from dementia, a degenerative cognitive disorder, for a few years now. An early sign of any form of cognitive decline is the inability to manage personal finances. Being X’s financial planner enabled me to recognize the symptoms early on and alert the daughter to X’s condition. X would struggle to remember recent conversations about her finances. She had difficulties filling application forms or signing cheques. Peculiar demands for redeeming large sums of money for insignificant payments, growing distrust of family members, and paranoia about losing all her money were some of the behavioural changes we noticed over time.

Disorders of such sort can create a litany of challenges for the individual’s families, who must now provide care in every aspect of the elder’s life, be it medical, personal or financial. They must also learn to deal with irrational and erratic behaviour, as was the case with X’s daughter.

The average life expectancy in our country is increasing each year and, hence, the odds that our ageing relatives’ mental faculties will deteriorate is fairly high. Elders with diminishing mental capacity are the most vulnerable to financial fraud and manipulation. Hence, you need to start putting in place guardrails to protect them today and in the future. Here are the things you can do.

1) Encourage the elder to appoint a trusted person—a friend or family member—who will be involved in her financial meetings and decisions. It is important to obtain the written consent of the elder in this matter. Every financial decision, whether it is about investments, estate planning, taxes, expenses or withdrawals, should be made in consultation with this designated person. If the elder is working with a financial adviser, the adviser must be informed about the trusted person, so the adviser can reach out to him to validate financial decisions or transactions.

2) Discuss with the elder if she wants to provide the trusted or designated person a mandate or a power of attorney (PoA) to act on her behalf. A PoA can enable the designated person to authorize financial transactions, execute the elder’s Will or be a trustee in the client’s estate plan. Making a Will is crucial for people with any form of cognitive impairment. If it is already made, ensure it is updated and kept safely.

3) Ensure that all money decisions with respect to investments, goals, taxes or expenses are documented and updated regularly. Doing so will not only help the designated person understand the elder’s requirements, but will also track any change in priorities or goals and hence identify inconsistences such as those relating to sudden expenses or withdrawals.

4) To help retain the elder’s independence and lower the impact of financial fraud, it is advisable for the elder to use a debit card instead of a credit card. A debit card can only be used to the extent of funds in the bank account, unlike a credit card, where the spending limit can be much higher.

5) With memory loss, the elderly may struggle to stay in control of routine payments such as utility bills, rent and insurance premiums. It is better to automate such payments, wherever possible, to avoid delays and penalties.

6) Collect, file and store important documents in a safe place and ensure the designated person holds a copy of all the originals. Ensure that the beneficiaries and nominees are properly assigned to all bank accounts and investments, including any assets held in the safe deposit. Create a digital file for all login details and passwords. Share this with the designated person only when the trust level is high.

7) A joint bank account may be opened with the designated person to enable him to transact on the elder’s behalf. However, this should be done only if there is a high level of trust, else the designated person can very easily misuse this trust for personal gain.

8) It’s important to simplify the financial and non-financial asset portfolio of the elder. Consolidate the portfolio and reduce the number of investments, so there are fewer items to monitor. Remove illiquid assets, such as property, from the portfolio, which requires management of rentals, tax, maintenance charges and so on.

If an elder has identified you as a trusted person, you are not only protecting her from being exploited by others, but also preventing her from harming her own financial well-being. She is fortunate to have your guidance and counsel in realizing her needs and goals. It also puts you in a position of great privilege and even greater responsibility.

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A longer holding period provides greater ability to ride through market cycles

As we enter 2020, let’s reflect on the decade that has gone by and what it meant to investors. The year 2010 started on a slow note for equity investors and the markets moved sluggishly till 2013. The tide turned in 2014, when the markets picked up by nearly 30%. A slump followed from 2015 until 2017, until the markets again climbed 30% from the previous year. Since 2018, the financial markets have witnessed some very interesting times.

Even though the mutual fund industry saw its assets under management grow over four times in the last decade, the last year saw unprecedented turmoil. The NBFC (non-banking financial company) liquidity crisis in 2018 resulted in the debt fund industry reeling from several credit events. Many equity funds also slipped into the red for most of 2019 though they have picked up momentum after the recent market uptick. Amid such turbulence, the investors who emerged victorious in the last decade were the ones who stayed true to their asset allocation and held on for the long term.

Long-term investing enables you to focus on what you want your money to accomplish over decades, not just months. Short-term planning, on the other hand, sways you in favour of emotionally-driven irrational behaviour. In such a situation, you may forget the rationale behind why a certain investment was recommended in the first place, and deviate from course. Your behavioural biases of greed and fear may interfere with carefully thought through investing strategies, causing you to either buy high or sell low. When the turbulence settles down, it can be difficult to bring the plan back to its original course since you may have lost significant time or money.

It is impossible to consistently time the market. In the short term, it is but a zero-sum game. Several studies have shown that the longer you stay invested, the higher your return on market-linked investments. A longer holding period provides a greater ability to ride through market cycles and recover from recessions. Hence, the probability of generating higher average returns on your investment increases with time.

Given that long-term investing has such strong benefits, what are the risks to such a strategy? Long-term investments are subject to four main risks: assumption risks, longevity, unforeseen cash outflows and black swan events.

When we create a financial plan that projects the future for several decades, it is based on the bedrock of certain assumptions. Such assumptions are made around returns of different asset classes, inflation, taxation, income and expense patterns, and risk appetites of investors. When some of these assumptions do not play out into the future, the long-term projections start to falter. For example, return expectations on equity and debt are usually based on historical data, which may not be an accurate predictor of future returns. Tax laws may change, impacting the overall return on investment, or inflation can be higher or lower than anticipated.

Living long and dying young are both undesirable from a financial planning perspective. Living too long necessitates stretching your money for longer than planned. Hence, if the plan assumes the average Indian male life expectancy as 75 years, but improved healthcare increases it to 90, the current plan may not sustain the money flow for the additional 15 years. Dying too young poses a similar problem. You expect to generate a certain income stream to build assets to support your family’s goals, when sudden death puts a brake on cash inflows. Hence the existing, limited assets are stretched to fund immediate and future goals.

Unforeseen expenses or unexpected job losses may force you to redeem your investments before time, sometimes at a loss, thereby shortening your investment tenure.

Black swan events such as the subprime crisis of 2008 or even natural disasters and wars can easily throw a well-crafted plan off kilter because such events not only erode your asset value but also have a deep psychological impact, where fear overrides rational decision making.

It is true that the future is uncertain. However, even if we cannot predict the future with a high degree of certainty, we do have the ability to make calculated assumptions, and this forms the basis for all financial modelling. Monte Carlo simulations, for example, help to model for risks in a plan by exploring the sensitivity to assumptions made, so that those can be factored in and planned for accordingly.

It is important to remember that a well-crafted financial plan factors both positive and negative outcomes. So, as long as you stay within the plan, you are more likely to achieve all the milestones across different time horizons. Simply put, a long-term view does put you years ahead of your investing game.

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Whatever you do, match your tenure and risk appetite to the average maturity

Over the last year or so, the sanctity of a AAA-rated bond has been shattered. IL&FS is a case in point. Following its default, several AAA- and AA-rated bonds such as DHFL or Zee Group have either defaulted or delayed on payments.

For any type of fixed-income investment, the return is not fixed unless you meet certain conditions, the primary one being that it should be held till maturity. If you hold a one-year fixed deposit (FD) to maturity, you should receive the promised interest. If you break it in three months, you get a lower interest rate. Similarly, with other fixed-income investments such as debt funds, the return is subject to credit risk, interest rate risk and reinvestment risk. If you hold the fund to maturity, you will likely receive the projected yield to maturity (YTM). The big if here is that YTM plays out only when there are no credit defaults or downgrades. The price movement until then is subject to mark-to-market risk and will fluctuate with interest rate movements. In the event of default, the net asset value (NAV) of the fund will fall to reflect the markdown of the defaulting paper in the fund’s portfolio.

So, what should be your strategy regarding debt funds whose value has eroded because of a credit event in some of the securities in its portfolio? How should you determine whether to exit or stay invested? Here are some guidelines:

Extent of exposure: Determine the exposure of the scheme to the security that has defaulted. If the exposure is less than 3%, assuming the remaining securities in the portfolio are in order, you may consider staying invested. This is because the markdown is relatively insignificant and should not affect the yield of the overall portfolio by a large margin. Note that many of the bonds that had defaulted have started paying back their dues, resulting in the recovery of NAVs. If the exposure of the defaulting instrument is more than 3% of the portfolio, you must gauge the scope of recovery of the bad assets. Also, if the remaining instruments in the portfolio are of poor credit quality, the chance of further defaults may erode the value of your investment significantly. In such situations, it is better to cut your losses, exit the fund and reinvest in a better instrument to recover the loss. One sweetener could be the tax offset you receive against other income to the extent of capital losses, thereby reducing your overall tax bill.

YTM: YTM measures the returns of the scheme if the portfolio is held from current date to maturity, after factoring in all the interest payments it will receive until maturity. If the interest rates are high, YTM is high. If, after factoring in the default or downgrade, YTM is still attractive, remain invested.

Yield spread: This refers to the difference in yields between two bonds of the same maturity, but differing credit quality. Given that banks and other lenders are now reluctant to lend to borrowers that are not AAA-rated, these borrowers are willing to pay higher rates. Sometimes these spreads are so high that even if you factor in future defaults or downgrades in the portfolio to the extent of 3-5%, the returns may still be higher than a 100% AAA-rated portfolio. Hence, if you are hunting for higher returns and are comfortable with credit risk and the resultant volatility, you can invest in a portfolio that has a mix of AAA- and AA-rated papers to take advantage of the wide yield spreads.

Exit load and tax impact: Debt funds are tax-efficient in that they grow on a tax-deferred basis. Unlike an FD, where accrued interest is taxable, you do not incur a tax incidence on debt funds until you redeem. Short-term gains are taxed at the marginal rate, and long-term gains at 20% with indexation. This results in a higher post-tax return compared to traditional deposits, even if the returns on both instruments are the same.

Redeeming your investment entails a tax incidence, where you will book capital gains or losses in the short- or long-term. If you invested a long time ago, you may have accumulated significant unrealized capital gains. Redeeming these schemes because of credit worries may result in a big tax bill. You need to weigh the tax bill against the credit concerns you have. Also, redeeming your investment prematurely may entail an exit load.

Whatever you do, match your investment tenure and risk appetite to the average maturity and credit quality of the fund, else the upheavals in the fixed-income markets will leave you feeling anything but fixed. You and your bond portfolio will be more shaken and stirred instead.

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