A frequent criticism by those who encounter freefincal articles or videos is, “This guy is very pessimistic about equity investing”. I also often get asked why that is the case. Please allow me to explain.
There is a difference between lack of faith and pessimism. If I lack belief in equity, I will not go near it. Pessimism does not preclude participation. It only serves as a risk management mechanism. Pessimism prevents faith from turning into blind faith.
Let us start with the data. There is no evidence that long-term equity investing will always be successful. However, there is enough evidence that there is a reasonable chance that long-term equity investing will beat inflation.
See:
That reasonable chance is enough to have faith in long-term equity investing. However, there are many caveats.
Just because equity, the asset class, could beat inflation, it does not mean we will! Let us set the PPF rate as a reasonable proxy for personal inflation (always higher than the government’s declaration).
After ten years, if we expect the “India growth story” to pan out as expected, PPF rates should be closer to 7%. So, any equity return above 7% wins the asset class. But hang on. We don’t expect 7.5% returns from equity (after tax). Most of the investors expect at least 12%. Not today. After 10 years or 15 years or more.
It is possible. But it is also not possible! If we expect 12% and get 8-9%, equity has won, but we have lost. Why? Because we expected more and invested less. Our corpus and our purchasing power will be lower than expected. The time lost in building the corpus is gone forever.
This is why pessimism is crucial. You recognise things can go wrong, and you plan for it.
- You expect less, so you will be disappointed less.
- You do not go overboard on equity. You have a balanced portfolio with no more than 50-60% equity exposure. You manage the portfolio with regular rebalancing.
- You have a variable asset allocation schedule to combat bad sequences of equity returns.
- You have a well-diversified bucket strategy for post-retirement income. See: Retirement plan review: Am I on track to retire by 50?
Once I have a “what if things don’t go to plan strategy” in place, I will stick to the plan.
- I have increased the amount I put into equity by about 20% on average from June 2008.
- I currently hold 60% equity in retirement and my son’s future portfolios.
I wouldn’t do this If I did not “believe” in equity.
We can only control the controllable.
- We can start investing in equity as soon as possible, giving us as much time as possible to combat the sequence of returns risk.
- We can invest as much as possible to ensure our corpus gets as close as possible to the target in case returns are lower than expected.
We have no control over equity returns. A return in the high teens can suddenly drop to toddlerhood or vice-versa. See: My retirement equity MF portfolio return is 2.75% after 12 years!
We should not be expecting any set return. Instead, we should prioritise steering our portfolio to the target corpus or above at any point in the investment journey. For me, pessimism is this course correction tool.
Each investor will have to devise their strategy. Anything other than blind faith (equivalent to leaving the fate of our hard-earned money to luck) should reasonably work.
The surprised investor is a failed investor – William Bernstein in the Intelligent Asset Allocator.
“Both optimists and pessimists contribute to society. The optimist invents the aeroplane, the pessimist the parachute.”
― George Bernard Shaw
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About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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