Wednesday, July 21, 2021

How to protect your finances during a slowdown

As reports of job losses, slowing demand and a liquidity crisis trickled in a couple of weeks ago, the stock market slipped. It recovered sharply a week later, but the decline was enough to jolt investors. The prospect of an economic slowdown has made people fearful. We look at steps that investors and consumers should take to safeguard their finances during the difficult times.

Don’t stop SIPs now

Discontinuing SIPs in a downturn is perhaps the biggest mistake an equity investor can make. It defeats the very purpose of an SIP by denying the investor the opportunity to accumulate more when prices are low. 

A downturn is the time when SIPs work to your advantage. It’s simple arithmetic. As markets turn weak and NAVs of funds go down, every SIP fetches you more units. A few years down the line when the market recovers, the accumulated units will translate into a huge corpus. Historically, investors have gained by continuing SIPs through lean market phases and sticking around for the longer term.

At the same time, experts say investors should moderate their return expectations in the near term. If your investing time horizon is limited to the next 2-3 years, then expect modest returns. If the goal for which you are investing is due in the coming years, then it would be best to withdraw the accumulated corpus or shift it to a liquid fund. 

This way, you will protect the accumulated savings from the vagaries of the market. But if you have a five year plus investing time horizon, persisting with the SIP could yield healthy returns. In fact, investors in midcap funds should even consider hiking the SIP amount to take advantage of the sharp correction in the segment, suggest experts.

Opt for less volatile funds

When markets are down, hybrid funds are best placed to protect the downside for investors. These are structured to limit volatility in returns. Hybrid funds come in different flavours. Dynamic asset allocation or balanced advantage funds invest across debt and equity, varying the exposure to either segment from zero to 100%, depending on prevailing valuations. Balanced advantage funds also include some element of arbitrage through equity derivatives.

Multi-asset funds, on the other hand, invest across equity, debt and gold in varying proportions, subject to a minimum for each segment. These afford a higher degree of asset diversification under one umbrella. Another category of hybrid nature is equity savings funds. The equity component in these funds is a mix of shares and equity derivatives—together comprising at least 65% of the portfolio. The rest is invested in fixed income avenues. . The lower direct equity exposure makes the funds less volatile even as they benefit from equity taxation.

Then there are regular hybrid funds categorised as conservative, balanced and aggressive. These funds always maintain some minimum exposure to both equity and debt—higher debt bias in conservative, higher equity tilt in aggressive and evenly distributed in balanced. Taxation can thus vary. But even among similar hybrid funds, there is lot of variety since fund managers take varying degree of risk within each asset class. Experts recommend equity savings funds and balanced advantage funds over others in this space.

Avoid investing in property

Builders and housing finance companies are luring buyers with big discounts and low loan rates. The housing market in top Indian cities has not done too well in the past year. Except in Hyderabad, residential prices in all big cities either fell or rose marginally. The situation is unlikely to improve in the next few quarters. A report by Knight Frank says the inventory in NCR will take more than three years (12.9 quarters) to clear if sales continue at the current pace. In Mumbai and Bengaluru, it will take more than two years.

This means investing in property is a no-no for now. If you are looking to buy for immediate use, go ahead. But if you plan to invest in a second property, stay away for now. There are better options available which can provide higher returns. This is especially true if you intend to take a loan. You will be paying 8-9% interest on the loan for an asset that is likely to appreciate by 4-5% over the next few years if you are lucky.

Diversify with gold, US funds

It is always a good idea to diversify the portfolio to reduce risk. During uncertain times, investors flock to the safety of gold—this is evident in the sharp rise in price of gold in recent months. Experts maintain that investors should keep around 10-15% of their portfolio in gold. However, avoid buying physical gold (ornaments or bullion) because making charges eat into returns and issues such as safety, liquidity and purity. Go for financial assets such as gold ETF or gold sovereign bonds. These allow investors to purchase gold in denominations as low as 1 gram while affording high degree of convenience and safety.

Another way to diversify the portfolio is by investing in international equities, particularly US stocks. US-focused equity funds provide two main benefits: One, they lend geographical diversification by investing in another country whose market has little correlation to the domestic market. They also provide currency diversification. Investments in US-focused equity funds are dollar denominated, even though you invest and redeem in rupees. As the local currency has the propensity to depreciate against the dollar over the long term, this gets added to the actual NAV return of the fund.

Create an emergency corpus

With jobs vanishing, an emergency fund is critical. Building a kitty to take care of medical or financial emergencies is the first step in any financial plan. But during turbulent phases, such a fund is indispensable. The rule of thumb says the corpus should be capable of funding at least six months’ expenses, though some experts suggest a larger fund given the rising uncertainty. It is best to take into account your earnings, expenses and family structure to arrive at the right size. Families with sole breadwinners will need a kitty capable of covering 9-12 months’ expenses. Besides routine expenses like school fees, groceries, medicines and utility bills, set aside an additional amount as cushion for any unforeseen expenses. This amount should be parked in liquid instruments, so that you can realise the proceeds the moment they are needed. You can also look at putting in three months’ expenses in regular FDs, with the balance being directed to longer-tenured debt funds that offer higher returns.

Reduce discretionary spends

In a slowdown, examine your expenses to identify ways to earn more. Tweak your lifestyle and budget to reduce discretionary spends and defer big-ticket purchases. Forgo the ‘prime’ memberships of food apps that encourage you to ‘save more’ when you eat out. If a couple is eating out thrice a month and spending Rs 6,000, cutting it down to once can help save Rs 4,000 a month. This is also the time to defer big-ticket expenses. Put plans to purchase a car, house or even a big holiday on hold till the time your finances are more secure. If it is not possible to defer these, look at second hand, preowned or refurbished options.

It is never a good idea to spend notional money, but this is critical during uncertain times. Don’t finance your purchases with money expected in the future, including salary increments, annual bonus, variable pay or profit from investments. Using credit cards to make big purchases depending on future lump sum remuneration should be avoided. Unless you have a steady job in a safe sector, use only cash, not cards.

The latte factor can yield substantial savings. This outgo includes small expenses that typically don’t warrant a second thought, such as chips, coffee, chocolate or an ice-cream. Over time, however, these add up to a large sum.

Cutting corners

Eating out: Once instead of thrice a month. Potential savings: Rs 4000

Cable plan: Reduce number of channels. Potential savings: Rs 500

Mobile plan: Move to a cheaper plan. Potential savings: Rs 500

Gym or club membership: Go jogging instead. Potential savings: Rs 2,000

Car pooling: Driving twice instead of five times a week. Potential savings: Rs 2,000

Ordering in: Twice instead of four times a month. Potential savings: Rs 3,000

Movie outings: Once instead of twice a month. Potential savings: Rs 1,000

In a month a family can save Rs 13,000

Take medical cover for family

When examining ways to reduce expenses, don’t even think of cutting out health insurance from your budget. In fact, in this uncertain environment, make sure your family has a medical cover apart from the group cover provided by your employer. Group medical covers are useful but do not help if you leave the job. Therefore, even if one has group cover from the employer, one should also buy a medical cover on his own. A Rs 5 lakh floater cover for a family of four (husband aged 40, wife and two children) will cost around Rs 15,000-18,000 a year.

Formulate debt strategies

The loss of a job can throw your finances into a tizzy if you have big loans to repay. Unlike corporate defaulters who have access to formal mechanism for loan restructuring, retail borrowers enjoy no such privileges. But you can leverage your repayment history and relationship with the lender to extract some concessions. Whether it is a home loan or a car loan, banks typically don’t want to repossess the assets and will try to avoid litigation as far as possible. In most cases, they are more than willing to make repayment easy. Approach the lender, providing justifiable reasons and request for rescheduling, before it initiates action on recovery. A word of caution: extensions will increase the interest burden. Ensure you prepay lump sum amounts once you recover from the financial crisis to get around this conundrum.

Unless you act fast, your credit score will suffer, making it difficult for you to obtain loans in future. You must convince the lender that the crisis is temporary and your intention is to eventually repay the loan. An unpaid loan does not mean the lender can ride roughshod over you. As a borrower, you are entitled to certain rights. You can approach the banking ombudsman if these have been violated.

Don’t jump jobs in a hurry

When the job market is looking jittery, it is best not to be adventurous with your career. A lot of new companies have mushroomed in the past few years, but many startups are bleeding heavily and could close down if the economy worsens. If you are planning to switch jobs, do in-depth study before you jump ship. Find out how financially sound the new company is and assess its prospects. In a slowdown, only the market leaders are able to keep their heads above water.



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