While reading a book titled “The Flight Plan” by Brian Tracy, I stopped after one particular paragraph. The message was so obvious and yet profound. The paragraph reads as under:
“Perhaps the greatest enemy of personal success is explained by the Law of Least Resistance. Just as water flows downhill, most people continually seek the fastest and easiest way to get what they want, with very little thought or concern for the long-term consequences of their behaviour. This natural tendency of people to take the easy way explains most underachievement and failure in adult life.”
Why is this so important in the context of investments? What is the significance of the above paragraph when one is talking about personal finances? Isn’t finance a hard core numbers subject? Isn’t investing all about rationality?
The above paragraph relates to one’s future successes or failures. Investment is also done for certain goals in future. Future is all about uncertainties. One needs a plan and a scenario analysis to deal with uncertainties of future. A financial plan is just that – a plan to help one reach financial goals in future. If a financial plan is carefully drafted, one must adhere to that unless proven that it is a completely wrong plan or that the initial assumptions were wrong. However, often people tend to change their financial plan in light of adverse short term price movements, without giving a thought as to what inflation can do to their future finances. At the same time, people have also changed the allocation to the riskier assets looking at the recent short term superior performance.
Any investor would be better off understanding the two prime risks of investments – volatility and inflation. Volatility of prices is the short term risk – inflation is long term risk. An investment plan must be made keeping these two risks in mind.
Inflation does not affect one much in the short term as the prices of essential commodities do not rise too much in short period, normally (However, one must not forget Zimbabwe of recent times or Germany during World War II). Because of this, we tend to take inflation very lightly and ignore it while planning for our long term goals. Volatility on the other hand is an immediate risk as the prices of various securities fluctuate in the short run. This is the difference between the two risks – the former being almost invisible in the short run whereas the latter being magnified by the discussions around it. We tend to, then, overweight volatility and underweight inflation.
It is due to such behaviours towards inflation and volatility that we often tend to change the portfolio allocation to deviate from the original plan in light of price volatility. This is similar to taking the path of least resistance. While faced with high volatility or sharp drop in prices, one tends to take the path of least resistance, i.e. getting out of the wealth creating asset at the worst possible time.
While each plan needs constant monitoring and course correction, same holds true for a financial plan as well. Such monitoring and course correction for a portfolio can be done through asset allocation and rebalancing. While course correction is necessary, the key word is “correction” and not just any change. A course correction ensures one makes changes such that reaching the goal becomes a possibility. This cannot be any different for an investment plan.
Let us end this article with a quote from Herodotus (also borrowed from the same book “The Flight Plan” by Brian Tracy):
“Some men give up their designs when they have almost reached the goal; while others, on the contrary, obtain a victory by exerting, at the last moment, more vigorous efforts than ever before.”
Rajesh Nair
CEO RajRak Investment Advisors
No comments:
Post a Comment