Now that 2020 is over, it is time to look forward to what 2021 has in store for us. The world is starting to pick up in the aftermath of a global pandemic, and we are about to see many new and unique avenues sprout up across various industrial sectors, including the investment avenue. Hence, 2021 can be an incredibly powerful year in your investment journey.
However, to be able to make successful investments, there are a few lessons and wisdom that you, as an investor, need to keep in mind. We discuss these below:
Importance of Emergency Funds
Indian women have long been in the habit of saving and hiding money in ‘chawal ka dabba’ in the kitchens and miraculously come up with it when the family is in dire need of it. This is the oldest form of emergency funds.
Emergency fund refers to the money set aside for emergency needs. It is generally saved for when an emergency creates turmoil in your life, and you need money for doing what needs to be done.
Emergencies, especially financial emergencies, are unexpected expenses that require you to use the money immediately. The critical element here is that for these expenses to be emergencies, they need to be of the nature of preserving your future, your health, and your assets.
Let’s try to paint a picture here. You think you have a high-paying secured job. You have skills which are highly sought after in the market, such that whenever you need a job, you can find one quickly and easily. And then… there’s a global pandemic. You get laid off. Companies are reluctant to hire new employees. Bills and payments start piling up. This is where you use your emergency fund.
The above situation is just one among many that can arise. Emergencies can take any form – unexpected medical expenses for self/family members, sudden major repair at home that needs to be done immediately, accident or vehicle breakdown, etc.
Most financial pundits and experts believe that a well-stocked emergency fund should be enough to cover three to eight months of monthly expenses. You don’t need to keep the entire fund in cash. You can set aside money and make a balanced portfolio of cash and liquid investments. Having an emergency fund is a sound finance practice, but COVID-19 has only made clear its importance.
Diversification is Essential
Diversification is an investment strategy that reduces the risk by allocating investments across various industries in different financial instruments in order to maximize the returns. Diversification is putting the money in different areas that react differently to the same event. It does not bring the loss to zero but reduces the risk of losing substantially.
Below we look at some of the advantages of diversifying your portfolio:
- If you invest in one stock heavily, you risk losing money if the investment sours. Therefore, investments made in different stocks are a safe bet so that your entire capital is not lost if one bad event hits one of the stocks.
- Diversification exposes the investors to more opportunities for return. By not diversifying, you’re missing out on opportunities in different asset classes that you’ve not been exposed to.
- Diversification safeguards and protects investors against adverse trade cycles.
- Diversification helps in reducing volatility.
Think of diversification as ornaments on a Christmas tree. Red and green together means you’ll fair better in all weather.
Importance of Term and Health Insurance
Term insurance is designed to provide a lump sum amount of money to the family members (beneficiaries) of the policyholders in the event of his death. Health insurance is a contract between the policyholder and the insurance company that agrees to pay for the costs related to medical expenses in exchange for a fixed premium.
Term insurance is a pure protection plan and is an absolute must for every person. In contrast, health insurance ensures that the individuals get timely cashless medical care or expense reimbursement in case they fall ill.
Both term and health insurance are two crucial insurance plans, each having their distinct benefits. Therefore, you must include both in your financial portfolio.
While term insurance ensures your nominated beneficiaries are taken care of in the event of your demise, health insurance covers the medical expenses you may have to incur in case of your hospitalization for reasons of accidents / critical illness.
Crisis = Opportunity
The ongoing COVID-19 pandemic has created an insurmountable economic and health crisis. No one knows how long it will take for the markets to pick up. As happens in any economic crisis, businesses were hit, markets adversely affected, and share prices plummeted. And what do investors do at the sign of falling prices? They haphazardly start selling their stock.
Behavioural finance explains this phenomenon – that investors are loss-averse as opposed to risk-averse. This is the general investor mentality. However, there are a few investors with the will to invest in times of a crisis. They do not succumb to the irrational fear and anxiety of falling prices. They buy stocks at lower prices from the scared sellers. The result – when the market picks up, the patient buyers see the price of their investment rise, and the fearful sellers are forced to invest at higher prices.
Therefore, while the falling prices may harm your investments in the short-run, an economic crisis may also prevent unique buying opportunities to grab the assets while they are on sale at lower prices.
Behavioural finance studies investor psychology that predicts how people tend to overreact, both in cases of prices falling and rising. What helps in such situations is keeping a level head and maintaining due diligence, which will help spot rewarding opportunities.
Don’t Mix Emotions and Investment Decisions
There is no certainty in financial markets. Maintaining and active monitoring of an investment portfolio is important for navigating through the changing strides in financial markets. What is more important is being able to control the behavioural impulses of buying and selling because of ups and downs in the market. Investors get influenced by their fears or media hype and start piling up investments at market tops and selling them at market bottoms.
Investing without emotion is easier said than done, but there are ways in which investors can be kept from chasing futile profits/gains and overselling in panic. Rational decisions are made when a balance is struck between the understanding of your risk tolerance and risks associated with your investments.
With these lessons in mind, you are now ready to move on to the big times and invest. Use these lessons to make wise investment choices to grow your wealth, especially if the pandemic ate it in 2020.
It is crucial you understand the avenues before you invest and choose the most suitable one based on your risk appetite and investment needs. Make sure you monitor your portfolio regularly and make changes to it as per changing financial needs and market dynamics.
On that note, have a great 2021!