Off late, I have been getting many queries on emergency cash, international investing and cryptocurrencies. It is only natural, what with these being trending topics. However, I find undue attention being given to these areas, which form a small part of the overall portfolio. The emergency fund, equity allocation and overseas investments would account for a maximum of 20-25 percent of a portfolio. Investors would have a larger proportion invested in safer instruments such as insurance policies or fixed deposits, which are low yielding and are a drag on the portfolio.
Undue focus for minimal returns
The queries on emergency cash are typically around how much and where to invest. But now, with the increased focus on this subject, I am being asked how to maximize returns on emergency fund. An investor wrote to me saying his bank reduced savings bank account interest and hence he wanted to shift to arbitrage funds as they are delivering better returns better than ultra-short duration debt funds. The reason for an emergency fund is quick access and not high returns. Arbitrage funds can have long periods of low returns and can have exit loads too and the recommended holding period is a year. Even if they give 1 percent point more a year than a money market fund, this translates to just an additional Rs 1,000 over a one-year period, on Rs 1 lakh investment!
Another query was on exiting a sovereign gold bond (SGB) held for two years and investing in the new series for a gain of Rs 10 per bond. For an investment of Rs 5 lakh, that translates to Rs 1250 profit from the transaction. It is the same story with IPO investments. The overall gains in rupee terms are minuscule and not worth the time and effort.
I find a similar experience in international investing. Investors consider a couple of international funds or some stocks for, say, 5 percent of their portfolio. With international stocks, there are high transaction costs and taxes. Plus, the tax compliance is so complicated. Yet, investors spend so much time on selecting stocks.
Missing the larger pie
In all this, they miss out improving the returns of the larger part of their portfolio, which is invested in traditional investments such as investment-linked insurance, fixed deposits and EPF. A portfolio with 75 percent allocation to traditional investments yielding 5 percent annually and the balance invested in equity (assuming 10 percent return) would yield 6.25 percent. Changing the allocation to 50/50 would increase the weighted average portfolio return to 7.50 percent.
As Steve Cohen said, “Leverage, concentration and illiquidity are the three things that can kill a portfolio.”
Here are five main factors investors should concentrate on in their financial life to improve returns.
-As shown above, having reasonable exposure to equities is imperative. Of course, the allocation will depend upon the risk profile. On an average, investors have 7-10 equity funds. Reduce this to 4-5 funds. The additional schemes do not provide additional diversification or returns.
-Stop jumping in and out of investments. It raises costs and not returns. Choose right and stay invested.
-Pick tax-efficient investments over those providing only tax deductions. The tax saved is usually expended. A tax-efficient investment means lower taxation and hence higher returns.
-Bring down the proportion of high-cost instant loans. Such loans, costing 16-22 percent annually, will do nothing positive to anyone’s financial life. Bullish markets often lead individuals into taking loans for speculating on stocks/cryptocurrencies. When the going is good, one may get superior results, but the same debt can be disastrous on the down-side and can wipe out your entire portfolio.
-Have enough emergency cash and health insurance. Both come before any investment. I routinely come across new investors buying stocks or rushing into crypto trading without giving a thought to financial security. Get the basics right: emergency fund, life and health insurance and saving for retirement.
The 5-10 percent of the portfolio invested in exciting investments such as bitcoins and international stocks and which investors are fixated on, can be done more as tactical investments to boost portfolio returns, but should not be the focal point of the portfolio.