Psychology behind Portfolio
I came across friends and acquaintances who asked me that, “Rana, you talked a lot about being frugal and investing. All these are talking about things in future. Future goals, future plans and the capital accumulated at the end of one or two decades. The time of youth won’t come back. What about enjoying your golden years?”.
Suppose I start investing now and stay frugal. Then when I am 50, I accumulated enough corpus to live financially free. But I have less energy to travel more, drink more, play adventurous sports and so on. What’s the point of having so much capital now?
This question trembles my mind like anything else.
Let’s simplify the scenario.
Should I invest more, or Should I enjoy more in my 20s & 30s?
Let’s play an example.
In this excel sheet, you can see 3 persons with different starting age 20, 30 & 40 respectively.
Retirement age is same i.e. 60.
Rate of return is same i.e. 10%.
Sam started early. As his salary was less, he could put only 10k per month.
John became serious at age 30, he determined to double the amount of Sam , i.e. 20k per month.
At age 40 , Tom began to plan his retirement and started with 30k , triple the amount of Sam.
Now when all of them reaches at age 60 , whom do you think have the highest corpus ?
Is it Tom, who is putting triple the amount? Let’s see below.
It’s Sam who topped the list.
How? Let’s see the excel sheet one more time.
Look at the last row. The number of years is on the side of Sam i.e. 40 years.
The power of compounding takes place over 40 years, which yields to the highest corpus even the contribution of Sam is a lot lesser than others.
Why did we go through this exercise?
It’s just to make you understand the power of starting early even with a smaller amount.
In the social media and blogging channels made the financial independence a super hype. DIY style investing meaning Do-it-style investing becomes popular now.
As the bull market continues after pandemic market fall, people believe in putting more and more into the equity asset class.
So for more than a while, we have thrown asset allocation and portfolio make over outside the window.
Because returns overcome the rationality.
There are now a lot of people with 100% equity and zero emergency fund. Although, those folks have a logic that they are young in their 20s or 30s and can afford to do so.
In future this will backfire, when the market corrects, and you’ll need more than a few bucks for some emergency. But your portfolio is in red and you have no other choice but to redeem some part of your portfolio to save yourself.
Let’s see this portfolio of 1 Lakh to understand this better.
Now you need to recover 5k to reach 1 Lakh. But currently you need 45k , so you have withdrawn 45k , so current value is 50k. But you have to recover 5k , which is 10% of your current value.
You have to recover 5k from 50k. That’s what changed in the second row , where your loss is amounted to 10% of your portfolio.
Lessons & thoughts from above scripts:
- Start early.
2. When you’re starting early, even the small amount like 10k also will have huge impact.
3. 100% equity will have a roller coaster ride. 60:40 of “Equity: Debt” or “Equity: Fixed income” ideal.
4. Emergency fund is important. 6 months of your current monthly income or 12 months of household expenses should be kept aside.
5. Invest on yourself , on your skill in your prime. If you’re doing job, focus on your domain. If you’re in software industry; be better at software development or IT consulting.
6. Enjoy your golden years (your youth) , but be disciplined towards putting your at least 15–30% of your monthly income towards investment.
7. Just because, you read multiple investment books, blogs and watched multiple youtube videos on personal finance , you won’t become a Investment Guru.
Edit 1: Changed the calculation figure in last image