Why we sell-off during market corrections?

Have we ever thought why most of us sell off our investments during market corrections? Is it because we need the money or is there any other reason(s).

We all must have taken a ride in the roller coaster; when it goes up we feel excited but feel scared when it goes down.  It’s the emotion of fear that the human brain is not trained to handle very effectively.

Our mind has one basic instinct to perform; to enable our body to survive. When we come across fear, initially the mind tries to overcome it but if it continues or magnitude of the fear increases, our mind will try and remove the cause of fear.

That’s exactly what happens when we go through the market corrections. As anything going down creates a sense of scare and feeling of fear, initially we try to cope up with it saying it’s just a minor correction and things would return to normal. But as correction deepens and market voices spread further negativity, our fear factor(losing more money) increases exponentially and that is the time when our mind finds it extremely difficult to cope up and will drive us to remove the cause of fear by selling off our investments. 

Once we have sold our investments and booked, otherwise, notional losses, we feel a sigh of relief. We no longer get affected by listening to all the negative voices as we have removed the cause of fear of losing more money.

So had we not seen the television or listened to negative voices of so-called experts during such correction times and held on to our conviction, we would have avoided distress selling and booking losses.

It is very important to understand that market corrections are temporary but growth is permanent. Market corrections are always followed by astounding returns. The best phase of the Indian stock market (Apr 2003 till Dec2007) has given 596% of returns in four and a half years despite having gone through several corrections en route. The graph shows it all.

courtesy : anchoredge

Conclusion

  • All previous corrections look like lost opportunity; Present correction is no different, Although it feels this time it’s different.
  • Market corrections are temporary; growth is permanent; Hold on to your investments until financial goal(s) is achieved. Switch yourself off from all market voices.
  • No one knows when the market would correct, how much will it correct and how long will it take to recover; but what matters is time spent in the market rather than trying to time the market. 90% of the gains in Sensex in the last 39 years have come only during 90 best days.

Need to discuss more, please feel free to book a no-charge consultation with me on this link: (https://calendly.com/rakeshgoyal)


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Understanding Investment Risks before Investing

Brutal fall in Indian stock markets over a period of last one month or so has left most of the equity portfolios bleeding. Fall has been so fast and vociferous that it wiped out almost all the gains of equity mutual fund schemes for last 3 to 5 years and in some cases up to 10 years. People who have started investing from 2018 onwards have their portfolios showing losses in the range of 20 to 50%.

This crash has left many investors wondering whether they were right investing in equity mutual funds?

During my interaction with investors, most of them ask “how much returns they are going to get on their investments?” Return on investments has no meaning by itself unless associated risk is taken into consideration. So the right question should be “how much risk is associated with my investments”. Understanding risk is important so that investors can take a informed decision before investing to get returns commensurate with risk.

Risk Capacity and Risk Tolerance 

More often than not, these words are used interchangeably but they have different meaning all together.

Risk Capacity. It’s the risk required to be taken by the investor to reach their financial goals. Your risk capacity is determined by comparing future cash flows to your investments( how much you expect to add or to withdraw from your investments) to your total value of investments . The more money you will be adding to your investments higher is your risk capacity.

Risk Tolerance. It’s defined as investor’s ability to absorb losses on investments. Low risk tolerance will make an equity investor sell equity investments at the very first instance of it going down whereas high risk tolerance means investor is willing to loose money and hold on to equity investments for potentially better returns. Following factors affect the risk tolerance
a. Time horizon for investments
b. Future earning capacity
c. Availability of other assets like house, pension, inheritance etc

So risk capacity and risk tolerance work together to determine the amount of risk required to be taken while planning investor’s portfolio. 

Investment decisions should ideally be guided by your risk capacity and not your risk tolerance, but often, it is the other way around. Risk return relationship is one of the fundamental laws of finance. You cannot get higher returns unless you take more risks.

The investor with low risk tolerance and high risk capacity needs to understand, that he or she may be compromising on their long term financial goals; on the other hand, an investor with high risk tolerance and low risk capacity needs to understand the potential implications on financial safety of their investments.

How much should be invested in Equity?

Rule of 100. 

Subtract the age of investor from 100, balance number suggests the maximum exposure of portfolio towards equity. e.g if the age of investor is 30 years, maximum 70% of his/her portfolio can be invested towards equities and for an investor of 60 years of age, 40% of his/her investments can go towards equities. These are average numbers and can be taken for planning purposes.

Rule of  Maximum Loss.
 
The Max Loss formula seeks to help investors determine the maximum percent of their portfolio that they should expose to equities. Max Loss depends on two factors:- What is the maximum percentage of your portfolio that you can tolerate losing in one year?What is the maximum percentage that you think the stock market can lose in one year?The formula of Max Loss % is as follows:

Max Loss %  =  (Max Portfolio Loss + Risk Free Returns) /
                            (Max Market Loss + Risk Free Returns)


Let us illustrate this with an example. Let us assume, you can afford to lose a maximum 5% of your portfolio value in a year and the maximum possible drop in the market in 1 year is 40%. The maximum percentage of portfolio loss should be worked out carefully based on your monthly cash-flows, your short term and long term liabilities and your average liquidity position in determining the maximum loss that you can tolerate.

In other words, if for some reason, you had to redeem your portfolio what is the maximum loss you can afford to bear. The maximum market loss should be based on how much the market fell on an average in bear markets. Let us further assume that you can get a risk free return of 6% (10 years GoI bond yield). The Max Loss % will be (5% + 6%) divided by (40% + 6%). When we do the math, we can have a Max Loss % of 24%. This should be equity allocation in your overall investment portfolio.

 Conclusion
1. Always invest in accordance with your financial goals.
2. Investors with low risk tolerance and high risk capacity should allot a portion of their investments in equity to meet their long term financial goals
3. One should always focus on the risks rather than expected returns. Expected returns are difficult to forecast.

Need to talk more on this? Please feel free to book a no-charge consultation with me on this link.(https://calendly.com/rakeshgoyal). Confidentiality is assured.


Are you paying Income tax on Interest Income?

As part of direct taxes, all of us are paying Income tax to Government of India. Income tax is levied on following two parts of income:

1. Earned income which is earned by us in a financial year(Apr to Mar)
2. And the interest income which gets accrued on our savings / investments

There is hardly any scope to save income tax on earned income beyond what is available as part of deductions in different sections of Income tax Act e.g section 80 C, 80 D etc

But how much Income tax we pay on our interest income depends entirely on us. Most of our money either keeps lying in Saving Bank Account(SBA) or Bank FDs and we land up paying almost 31% of interest income as Income tax. 

So is there any way out?

Instead of keeping surplus money in Saving Bank Account or Bank FDs, we may like to invest this money in debt mutual funds. There is no tax liability as long as you remain invested in debt mutual funds(no TDS). If you remain invested for at least three years, you qualify for long term capital gains (LTCG). Should there be any requirement for redemption after three years, you get tax advantage on LTCG due to indexation and flat tax rate of 20%. Effective tax rate works out to be approx 8-9 % for people in 30% tax bracket.

let’s understand through an example. Let us assume we invested Rs 1 Lakh for 3 years and 1 day in a short duration debt fund in FY 2014 – 15 and redeemed in FY 2017 – 18. Assuming annualized pre-tax return was 7% compounded for these three years, tax calculations would be as shown below:  

In case of Bank FD, tax liability would have been Rs 6751/- assuming same rate of interest thus saving almost 73% on taxation.

And  on top of it, you get better returns on debt mutual funds as compared to SBA / Bank FDs.

Think over it…