Due Diligence. Learning from Lehman

It has been 10 years since the financial crisis — with global major Lehman Brothers filing for bankruptcy, triggering a world-wide market collapse of epic proportions — unfolded. Indian indices fell nearly 60 per cent from their January 2008 highs by October that year. But after the 2008 crisis, there have also been three other periods of significant corrections — 2011 (sovereign debt problems in Europe and West Asia), 2013 (tapering of financial stimulus by the US Federal Reserve) and 2016 (Brexit and the unexpected political victory of protectionist Donald Trump in the US) — when markets corrected by 12-25 per cent.

As an investor, it would be impossible to predict the coming of a crisis. But you can certainly stay prepared and take steps to insulate your portfolio from severe erosion, and tide over many crises till you reach your goals.

Stay calm

After the stupendous rally of 2003-07, the tanking of the market would have eroded the value of most equity investments. Such corrections make cynics of investors and most of them tend to exit equity instruments for good, complaining that stock markets are ‘gambling dens’.

But if you had remained patient through the correction of 2008 and stuck to your monthly SIP investments in relatively less-risky large-cap funds, you would have been sitting on annual gains of 15 per cent over the last 10 years. A lump-sum investment even in an index fund, made during the market depths of October 2008, would have risen more than four-fold since. By being able to buy from rock-bottom levels, your investments have a better chance of heading considerably north.

Therefore, not panicking and sticking to periodic investments for the long term pays off — more often than not, quite handsomely. All small corrections may not turn out be great investment opportunities. But market declines of more than 20 per cent should push you to get into active investment mode.

Don’t have excessive debt

Much of the global financial crisis was due to excessive leverage that institutions took on and lent to risky customers, resulting in major defaults, heavy losses and a massive liquidity crunch in markets across the world.

As an investor, the lesson for you is not to go overboard on loans and credit cards. Ensure that you do not use more than 50 per cent of your credit card limits. Also, spend only as much as you can fully repay in each billing cycle.

All your EMIs together must account for less than 40 per cent of your overall income.

Next, when markets are falling like nine pins, you would be tempted to sell out at a loss, especially when you need the money for emergencies. You should definitely avoid selling out cheap.

Building a contingency fund — equivalent to about six months’ total household expenses — is very important for you to tide over financial emergencies relating to healthcare or loss of job. This amount must be saved in a savings account (with a sweep option) or in carefully-chosen liquid funds.

Having this corpus means that you can wait till you recoup your losses and need not force yourself into a distress sale of investments.

Asset allocation

In the near exponential run in the market through the previous five years leading to 2008, themes such as infrastructure, real estate and capital goods delivered exponential returns, much more than what the broader indices recorded. They fell with a thud and many stocks and funds in these segments still continue to languish at the bottom of the pile.

There are two lessons to be learnt here. One, when your funds and, indeed, the market delivers multi-year bull runs (running up manifold over shorter time-frames), you must book profits and move the proceeds to safer debt avenues. You should have a target return for your goals and anything in excess of that level needs to be booked quickly.

Such massive run-ups also mean that you may reach your intended corpus ahead of time. That should be another reason to get out of equity and go for safer debt instruments such as fixed deposits.

Finally, avoid buying flavour-of-the-season funds or stocks and stay away from a concentrated portfolio, so that you can gain from rallying markets and remain relatively insulated during falls.

Having balanced asset allocation with investments mainly in equity, debt and, to a lesser extent, in gold and real estate (for self living alone), in keeping with your risk appetite and time horizon for goals is critical.

Always invest only sums that you would not need for at least five years.

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