Last Updated on August 20, 2020 at 9:02 am
In this edition of reader story, Vignesh Srinivasan describes what he has learnt about money management over the last couple of years. How asking “What makes one a bad investor?” has helped him build a robust framework based on four pillars – Investments, Taxation, Administration & Protection.
About reader stories: In this category, we showcase the money management experiences of readers. Check out some popular articles: (1) What 25 Years of Tracking Expenses Taught Me; (2) How I achieved the dream of an own house & became debt-free by 36. (3) I met an accident the day I got married and learned key money lessons (4) How I turned my life around & charted my own money course (5) I achieved financial independence at 35: My journey and lessons and (6) We lost sleep after using a retirement calculator! This is how we recovered.
You can also explore the full reader story archive. Do contact us, if you have a story or know of a friend’s story that the DIY community would benefit from. Editor’s note: To preserve the emotions of the author’s journey and their thinking process, reader stories are published in an as-received format.
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They say that “If you don’t look back at your past self from a year ago and feel ashamed, you aren’t progressing enough”. While this may seem like an aggressive quote, it does apply very well to someone who’s just starting out in a new field. It’s certainly been relevant for me as I look back on my personal finance journey spanning a grand total of … 2.5 years.
But first, some background –I got into personal finance in early 2018, at the age of 21, in what was a pretty unusual way to enter the field. I started by reading books like John Bogle’s Little Book of Common-sense Investing, The Four Pillars of Investing (highly recommend this), and A Random Walk down Wall Street.
While these are good books in their own right, it meant I had tunnel vision as I entered the markets with the view that only index funds (+ active funds, in an Indian context) worked on a consistent basis. This reductionist view of the markets was helpful though, as I stayed away from the likes of trading, F&O etc that were outside my circle of competence.
I got some of the basics right – 6 months emergency fund, minimizing my Income tax, investment tracking, term insurance (although I did end up adding a couple of riders) but my naivety was still visible in my thought process re: equity. As far as I was concerned, equity was this magic wand that worked in the ‘long run’ and I could even see myself at the ripe age of 60 counting the millions made through a smooth 12% CAGR over 40 years.
I’d even gone as far as writing to my HR, as a fresher, asking them to not contribute any money to my EPF but to instead give it to me directly. Investing this money in an equity fund just made so much more sense (I did the numbers on Excel. They don’t lie.). Needless to say, I’m now glad they refused. My own portfolio, of course, was chosen ‘carefully and rigorously’ by looking at 5* rated funds from Value Research.
Fast forward to 2020 and I am now also in charge of my parent’s finances. The lockdown gave me the perfect chance to take a deeper look at the support structure surrounding our finances and to kick start the planning for their withdrawal stage. Luckily, my quest for knowledge coincided with me finding the Freefincal and Subramoney YT channels and this proved to be a real game-changer.
While I got some granular details on how to choose my investments better (Adding more mathematical rigour to my selection process, understanding a fund’s history etc), the main value I derived from both Pattu and Subra was the scenarios where things can go wrong, or have gone wrong in the past. I’d argue that this is just as important, if not far more, than knowing what/where to invest. This concept is best encapsulated in a mental model called ‘Inversion’.
Inversion is a really simple, yet powerful, concept – If you want to know how to become a better investor, flip/invert the question on its head and ask “What makes one a bad investor?”. This inverted question is often far easier to answer and coaxes out the exact pain points to address. Some examples where Inversion has helped me are:
- How can I ensure my parents have a smooth retirement? – Inverted: What can mess up their retirement journey? – The sequence of return risk, longevity risk, lack of Insurance/emergency buffers to prevent portfolio drawdown, inappropriate risk-taking etc
- How can I ensure my dependants will be fine if anything happens to me? – Inverted: What can cause my dependants to have problems if anything happens to me? – Lack of insurance, will. Incorrect nominations. Poor tracking & sharing of finances, important documents. Lack of insight into how the money should be handled in your absence.
Adding my learnings together, I was able to come up with a high-level framework of personal finance: A building that is supported by 4 key pillars –Investments, Taxation, Administration & Protection (Or as my friend Kaushik lovingly calls it – I.T.A.P.). While these pillars deserve their own posts, an overview might be useful:
Protection – Adequate life insurance (To ensure your dependants don’t struggle in your absence), Health & accident insurance (To ensure the expenses don’t cause a financial strain & portfolio drawdown). Emergency funds and possibly, a medical corpus.
Investments – Asset allocation, risk management, goal-based planning…. The usual gospel
Taxation – Minimizing the amount you pay to the taxman and the corresponding impact it has on your portfolio. Understanding the power of capital gains vs income tax
Administration – This is arguably the most important, and the most overlooked, pillar. It encapsulates a wide variety of actions ranging from financial tracking to the formation of a continuity plan (To ensure your dependants can continue in the case of your demise). Central to these is ensuring that wills are made, the right nominations have been selected/updated, and the sharing of important documents.
The real power of the framework comes not from viewing the pillars individually, but holistically. What gives our investments the breathing space to work well in the long run, is the supporting cast around it. Protection covers for the rare, high impact scenarios that can really hurt your portfolio. Administration ensures that you keep proper track of your portfolio and that there is a continuity plan in place. Without these support structures, any financial journey is liable to be shattered at the onset of an adverse event (Job loss, accident, death etc).
To end this post with, here are a few easy wins that can be easily implemented for a better financial journey:
- Documentation/Will/Nominations – Once you’ve started putting your money anywhere, this becomes an absolute must. It will be a travesty for your dependants if they don’t know where you’ve invested or are unable to access it.
- Don’t only stress on the right investment choice, focus on the holistic view of personal finance and how the other pillars enable your investment. For your investments to run un-abated & fulfil their goal, your liquid funds, insurances, & administration need to work in tandem.
- Inversion is an amazing mental model that can be used to stress-test your finances. Always invert and try to break down your hypotheses and processes to identify any points of failure.
- Learning behavioural psychology, particularly those topics relevant to our biases and the ways in which we fool ourselves, can prove to be highly useful. This is key to ensuring one doesn’t get carried away by various market narratives.
- “Over-diversification” will hurt in equities but can prove to be useful in debt. I’ve made 2 mistakes in the debt space which highlight this:
- Almost 60% of our liquid fixed-income portfolio was invested in 3 Franklin funds, all of which were shut-down. As a family, we were lucky to escape unscathed as my mother’s job was un-affected and we were able to build up a decent buffer in the following months. This was a real-life lesson on Credit Risk and I shudder to think of the ramifications if this had happened during my parent’s retirement phase.
- We had invested in the debt of a foreign company (Which does most of its business in India but is HQ’d abroad) which was offering a great return (For the added risk, of course). Now, this was a pretty good company that recently raised equity capital from the likes of Mukesh Ambani but it was still in its early stages. We’d been investors since 2017 and picked up the options to add more $, all while it silently crept up to 5% of our entire portfolio. We’ve been incredibly lucky that this company was able to weather the COVID-19 storm well (being in the real estate space, no less) but that’s just too much exposure to an unlisted bond of a non-public company, given our humble portfolio size. Outcome bias shouldn’t cause one to shirk away from the fact that this was poorly handled by us.
Lastly, I want to thank Pattu for giving me the opportunity to write this post and share my evolution as an investor. I’ve benefited tremendously from the knowledge and resources that have been shared on this site and am hoping to pay it forward by sharing my learnings. I am by no means the finished article but I’m hoping this post gave you a few points to ponder about. Take care, stay safe, and good luck for the journey ahead.
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