Case Study: An investor in panic mode

With equity markets running into rough weather, the resolve of even the most steadfast investors has been tested. And rightly so. When equity markets were surging northwards, not many would have foreseen such a drastic turnaround. Now, its rather commonplace to find investors in panic mode. We recently interacted with such an investor. His panic was the result of acting on half-baked information and poor execution of right ideas. Since the case entails some common investment mistakes, knowing more about the same can prove beneficial for investors across the board.

Facts of the case

Rajiv (name changed to protect the client’s identity) is a 35-Yr old software professional. His family comprises of his wife and 3-Yr old son.

Among other objectives, Rajiv wants to accumulate a corpus to provide for his son’s education. He has set himself an investment horizon of 15 years.

To begin with, Rajiv has started investing in the Public Provident Fund (PPF); the intention being that the maturity proceeds would be exclusively used for his son’s education.

Given the 15-Yr time frame, it is apparent that Rajiv understands that the importance of being invested in equities for the long-term. He chose the mutual funds route to make equity investments. He has been investing in mutual funds since 2006.

Panic sets in
Barring the past few months, Rajiv has seen his mutual fund investments flourish, thanks to the rising equity markets. Now with the tide turning, Rajiv has second thoughts about his investments. Also, he is perturbed by the fact that his investments have fallen much harder than the markets (indices) and most other equity funds. Rajiv’s panic stems from being aware of the fact that, he runs the risk of not being able to provide for his child’s education as intended.

Problem areas and solutions
When Rajiv approached us, we realised that the lacklustre performance of his mutual fund investments, was just one among several problems that he had to deal with.

Let’s begin with the objective of providing for his son’s education. While Rajiv got the part about setting an investment objective right, he failed to quantify it in terms of the amount that he needs to accumulate and a definite investment plan to achieve the same. In other words, he had not targetted an amount for his child’s education and worse, he had no idea how the same would be accumulated. The result – investments made in a haphazard manner.

The solution – Personalfn’s team of financial planners helped Rajiv arrive at an approximate sum of money (based on interactions with him and his spouse) that would help provide for the child’s education. This was followed by drawing an investment plan to achieve the stipulated sum over a 15-Yr period.

Now for the mutual fund portfolio. While Rajiv understood the importance of equities and made the right choice in terms of the investment avenue – mutual funds, his selection of funds was flawed. Rajiv’s portfolio was dominated by thematic/sector fund new fund offers (NFOs). Diversified equity funds with a proven track record accounted for only a minor portion of the portfolio. Ideally, the allocation should have been the reverse. The unique investment proposition offered by thematic/sector funds and their high risk-high return nature was lost on Rajiv. Expectedly, the poor showing of his portfolio in the wake of market volatility became an overbearing concern.

The solution – The investment plan we prepared for Rajiv will come into play at this stage. We recommended equity funds that were right for him i.e. ones that can help him achieve his stated goal. We also recommended how he could rejig his portfolio in a staggered manner. Of course in the new scheme of things, the systematic investment plan (SIP) route of investing is expected to play an important role, instead of lump sum investing, which was Rajiv’s preferred investment style.

Rajiv’s plan of being invested in both PPF and mutual funds (i.e. across asset classes) was a good one. However, he was unaware of the allocations to be made to the avenues. As a result, the investments were made in a random manner.

The solution – Based on the investment plan drawn, we helped Rajiv with allocation levels for both the investment avenues. Also, going forward, we will advise him on modifying the allocation levels and introduce new investment avenues as well when the target date approaches.

Finally, the biggest problem that Rajiv faced was his imperfect understanding of equity investments. While Rajiv was aware of the potential of equity investments over the long-term, he failed to appreciate the high risks that equities could expose investors to over shorter time frames. Having seen equity markets rise almost secularly over the last few years, Rajiv (like several other investors) was never exposed to the downside (read risks) of equities. Therefore, the present volatile phase resulted in Rajiv being caught wrong-footed and hence, the panic. It can be safely stated that as a result of our interactions, Rajiv has transformed from a panic-stricken investor into an informed one, with better control of his finances.

In conclusion…
Rajiv was afflicted by problems like a random investment style (lack of a defined investment plan), absence of a core investment portfolio (investments unsuitable for him) and investments based on half-baked information, all of which are commonly observed investment mistakes. The result was that even the best of intentions came undone. Investors on their part would do well to steer clear of such investment mistakes, so that they stay on course to achieve their financial goals.