Good Personal Finance Questions with Arbitrary Answers!

Published: October 8, 2016 at 8:56 am

Last Updated on

Here are a few perfectly relevant and ‘good’ questions in personal finance or money management with arbitrary answers! In my opinion, the following questions are distinctly different from those that seek the best insurance or investment products to buy. There are right questions to ask, the answer cannot be based on a formula.

First some book news

You Can Be Rich With Goal-based Investing: A book by Subra & Pattu has met with a fantastic response! Thank you very much. We now wait with bated breath for your feedback. I am looking for ways to promote the book. Can you suggest some methods? The obvious choices like social media advertising are on my list. Thanks. Now over to the post.

How long should I wait for my active fund to beat the market?

Suppose you are holding a large-cap or small/mid-cap fund? The respective fund manager is expected to “beat the market” (respective benchmarks) to put it crudely. Does beating the market mean more returns, or less risk or both? Debatable! For the case of simplicity, let us assume that it means more returns.

Now, how long should I wait for my actively managed fund to beat the market?

I have usually maintained that I would prefer to give it at least 3 years or even a bit more. But this is an arbitrary answer. There are those who say, if the performance dips for a few quarters, exit. Then are others who want to quit if the fund drops a star.

Nothing wrong with the question. It is a right one and a good one. However, open-minded people will realise that the answers are arbitrary. I guess that as long as we do not end up cluttering the portfolio (unable to justify fund positioning to ourselves) and do not pay much of tax and exit load, it should be okay.

I have held on to temporary underperformers for years together. Only to see them spring up within weeks. That is the nature of the market.

I have also been subjected to the investor’s curseMy fund (A) underperforms compared to another fund (B). I stop investing in A and start investing in B. A little while later, A edges past B!

Patience plus objective reviewing helps, but the answer is still arbitrary per se!

How do I handle a 2008-like situation?

Again a very good question that everyone should ask. Answers are not easy. A crash when viewed in hindsight, is very different from a crash in real-time. We often would not or cannot realise what is happening.

In hindsight, it appears as if the crash occurred because the index PE was high. However did the US housing bubble burst because our index PE is high? Crashes are triggered by specific events and that does not include a high PE!

If the answer to ‘how to handle a crash’ is to quit and stop loss, then we might be exiting at the drop of a hat. In real time, what looks like a future decline can quickly change over a few days.

My point is, formulaic answers are not possible. We will have to recognise that risk management is

1 contextual  Sometimes a spike in market volatility (measured by India VIX: The Stock Market Volatility Index) matters. Sometimes market valuations as indicated by the health of one’s portfolio matters. One can contain losses by being systematic: Simple Steps to De-risk Your Investment Portfolio

In addition to regular rebalancing, one can also rebalance the portfolio each time the market is at an all time high or rebalance just before Lok sabha elections (uncertainty can increase the VIX index) etc. This is for managing losses and not preventing them.

2 dynamic  Portfolio management involves playing it by the ear. That is we will have to react to specific market movements. Sometimes, the reaction can be – no action and sometimes, book profits or invest more. Such actions depend on your requirements, which are dynamic too.

The answer to this question is arbitrary if you ask someone else! A personalised solution (which is also dynamic) will work as long as we do not worry about whether it the ‘best’ or not! If the aim of asking the question is to prevent losses then it is a wrong question!

How much mid-cap and small-cap stocks should I have in my portfolio?

There are some amusing answers to this based on past performance. Somehow I think such question arise from a fear of being left out. I hold a portfolio with a large cap tilt and I see 40% return from DSP Microcap in the past year and want to increase exposure to that. Then I hear someone say that large caps will underperform other categories in the “long run” and think my portfolio construction is all wrong.

The main problem is that many of us think that we can withstand market ups and downs and things will turn out okay in the end. As mentioned above, market shocks are dynamic. Each crash we have witnessed so far has been unique and I think that pattern is likely to continue.

The problem with mid and small cap stocks is the volatility. They can deliver great returns for a couple of years and then offer nothing for the next few. The argument that “my goal is far away, and I can wait” is a little too simplistic. Returns from a particular asset subset depend on when we choose to look!

I can come up an ideal asset allocation among large, mid, small and micro-cap stocks based on past performance. What good would that do?

I can also repeat this exercise in real time and find out the desired asset allocation once a month, once a quarter etc. The question is, how many of us are interested in such level of analysis and does such number crunching help in the first place?

Whatever we do, the answer to this question is arbitrary per se. Nothing wrong with the question as long as the objective is not to obtain “best returns”.

Assuming we stay invested, our ability to handle risk changes with time. We can always gradually take on more volatility by increasing mid/small cap allocation after we get comfortable.

The central point of the post: many aspects of money management involves taking things as they come. We must know how to identify and manage risk, but what we actually do depends on the situation. That sounds a bit scary, does it not!

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps