The Stock Market is a Giant Distraction to the Business of Investing
The Late John Bogle (Founder of the Giant Vanguard Group) said these pearls of wisdom “The Stock Market is a Giant Distraction to the Business of Investing”.
I would add my 3 words to this and say, “The Stock Market and The Economy are a Giant Distraction to the Business of Investing”. What do I really mean by that?
Besides the stock market, most people are obsessed with the Economy even when their Personal Economy is doing fine. Did I say Personal Economy? Yes, I did, and it is far more important than the broader economy. Yes, I know there are linkages between the broader economy and your personal economy, but it is very important to understand the difference between the 2 and most importantly which one is more important. A lot of people look at the Economy and imagine that things are already happening to them when the reality is that their Personal Economy is fine (Might not be great as earlier but it’s not doomsday either).
Just look at this sketch. Just like the Economy of a country, there is your Personal Economy and you are the Prime Minister as well as the Finance Minister of that economy.
In your economy, these are the 5 things that are important:
- Your Personal Income
- Your Regular Expenses
- Your Financial Goals and Funding Needs (even Giving is a Need that gives one immense satisfaction of having helped someone. Note that I call Giving a Need)
- How has my income changed because of this crisis? Is there a pay cut or loss of income?
If the answer is “No”, then you are doing fine.If your answer is “Yes”, first evaluate whether the quantum of cut has a material impact on your lifestyle or not. If you have sufficient assets, then you are fine. If your income has gone down drastically and no assets, then the first step is to reduce expenses and figure out sources of cash flow. This is a column in itself so not going too deep into this but wanted to give you a perspective on how to look at this.
- What about my expenses? Have they gone up or down?
I can bet with a lot of confidence that for most people expenses have gone down and thus they are saving more than what they were earlier. Utilize this to boost your contingency funds to at least 12-18 months of expenses and goals. Once you have sufficiently addressed the contingency funds, then think about investing the surplus funds.
- Have my assets gone down and if so by how much? If they have gone down, are they impacting my lifestyle, liquidity needs or funding my goals in any way?
Though the markets have gone down by 30% + and a lot of stocks down by 40-50%, the majority of the well managed portfolios are between + 2% to -15% based on an asset allocation of 50% Equity and 50% Liquid/Debt. There are many permutations and combinations here and I won’t cover all of them here but the key point I am trying to drive is that asset values going down have not impacted lifestyles and liquidity needs of people who have done prudent financial planning. I have seen so many retirees with no source of income other than their portfolio but they are comfortably managing their day to day income needs and will do so even if the markets are at the current level for the next 3 years.
Even if you have not planned, just because asset prices have gone down does not mean that your personal economy is in trouble. As long as your assets are more than your liabilities and even more importantly as long as you have a steady source of income /liquidity you should be fine but, start the process of planning immediately to figure things out.
- What about my liabilities? Is there a need to borrow to fund certain goals?
The sensible use of debt is a strategic advantage even in a personal economy. If you have no liability, you are in great shape but even if you have debt that you can comfortably service, that is fine too. Figure out how much can you reasonably borrow at low rates of interest and if you can service it comfortably should the need arise. You may never use it, but you at least should have an idea about this. This is especially relevant for business owners.
- Are any of my goals coming up and how am I funding these? Is there a funding gap or do I have adequate liquidity?
As I mentioned earlier, if you have gone through the process of financial planning, you should be fine because your assets will be allocated in a way that you will have liquidity for your financial goals (even though your portfolio might be down). On the other hand, if you had just looked at products and invested for performance (putting short term money into equity – people do that) without considering the risk, you need to start figuring out where you could raise that additional money from. Look at all the sources such as your other assets, your ability to borrow, ability to get payments in advance (low probability but still an option) to address the shortfall. For example, if this was a vacation goal, you would anyway not be able to do this now and you get additional time. However, if this was an education goal for which fees must be paid, then look at different sources. You should consult a qualified financial planner to help you plan your financial goals.
Remember that your Personal Economy can be Strong irrespective of the Economy. I am sure you know that the root cause of most personal finance disasters is an inability to control spending. This happens even when the economy is good or great.
Your Personal Economy rests in your Hands and on the Pillars of Your Income, Expenses, Assets, Liabilities and Most importantly your Lifestyle (and your Financial Goals).
You are the Prime Minister and Finance Minister of Your Economy. It is important that you play these roles well or get a wise Personal Finance Minister to help your Personal Economy make Wiser Financial Choices.