Buy insurance for your portfolio

This is that time of the year when most salaried employees start thinking about tax saving and inevitably one of the first things that people think of is insurance. It is probably our conditioning that we buy LIC (and these days from private insurers) policies without blinking much of an eyelid. 
What exactly is a life insurance policy? It is nothing but a put option on your earning power. Basically, it protects your family from the loss of your earnings if and when you are no longer there. Simple.


However, a lot of stock investors do not think of buying similar "insurance" policies for their portfolios. I call these stock insurance policies "catastrophe insurance". No, they are not sold by LIC or other such insurance companies. They are traded on stock exchange in the form of PUT and CALL options. 


One way of buying such an insurance is to buy out-of-the-money PUT options of the index for a long duration. For example, if you buy a 4000 or 3900 PUT option for the month of February or March now, you are sort of covering a part of your losses in case the markets tanks. This typically makes sense for people who have very large equity portfolios. You pay a low/moderate premium to get some peace of mind. The way the markets are poised right now, I think it would be a prudent thing to do.

Parag Parikh's view on the US downgrade by S&P

We tend to make decisions based on the currently, readily available
information vividly displayed. Open any newspaper or flip through a business
channel, or go to a party, there is only one talk of the US being downgraded
by the S&P. Why? Because of the high fiscal deficit and the high amount of
debt. Is this really new? Did not the world know about it? So why the
reaction? Well it is because of the availability bias. Today the downgrading
is the centre of attraction. 

Go back a couple of months in the memory lane.
The 2G scam, the Anna Hazare fast, the CWC games scandal. When they were the
centre of attraction the newspapers, the TV channels concentrated only on
those news. Although none of the matters have still been sorted out, how
much reporting does one see? Over the next week the euphoria on the down
grade will die down.

As the fear dies down and the reality dawns, things will improve. When this will happen, no one knows. It can be tomorrow, a week or a month or a year from now. You make the choice.

One another bias investors are prone to is the Representative Bias. The 2009 crisis still haunts investors. The way the stocks lost values is still very vivid in the minds of investors. One should not consider the recent downgrade and the fall as a representative of the 2008/2009. This is very different. We are not in a situation like that.

Lastly coming back to the downgrade by S&P. If they were so good in their judgments what happened in 2008/2009? Were they able to assess the quality of derivative mortgage backed securities which led to the downfall of so many financial institutions and banks? 

We are living in a society where insanity and irrationality works. The best way to survive is to follow a process and be disciplined to keep to that. The process: Buy good sustainable businesses available at attractive valuations and run by good management. The discipline: Think long term and not be swayed away by market swings.

Read the full post here: https://www.ppfas.net/blog/2011/08/08/sp-downgrade-caution-or-an-opportunity/

2008 vs 2011 - Which is a greater crash?

Fundamentally, we are not even close to the problems that were there in 2008. Credit markets froze then. Now, nothing of the sort is happening. S&P is basically getting back at the political top brass in the US. These were the people who lambasted them for not providing enough warning before the housing crisis and S&P, Moody's and Fitch got the wrong end of the stick back then. Now is their time to hit back. Revenge, as Dan Ariely argues in his latest book, is a very powerful motivation.

Funds and Institutions will probably not stop buying US bonds because a "A" was replaced by a "+" in somebody's report!! More because there is no credible alternative. Euro is in worse state, and Japanese Yen is not even in the running anymore. In this turmoil, Gold & Silver might shoot up along with the clamour for a gold-backed currency.

If we keep our heads above water now and can invest, 12 months down the line, we'll be happier for it.

My only caveat is that there should be no more adverse developments. Then the time horizon may need to be stretch from a year to more.

Markets Correcting: Should I buy or Sell?

ttA frantic phone call on my mobile today from a friend from Pune, India today got me thinking. The Sensex has corrected by nearly 1350 points in the last 5 trading sessions. The market participants are appearing on TV and pronouncing gloom and doom. Interestingly, these same people saw nothing wrong with the market a week back!
So, here is the gist of what I had to say to my friend today.

1. I have no idea if the market will go down further from here.
2. I have no idea if the market will go up from here.
3. Think from a overall business ownership perspective and not a stock ownership perspective. The last time I checked Ratan Tata had not sold his stake in Tata Motors or Tata Steel when the prices had collapsed in 2008, neither did Mukesh Ambani or Sunil Mittal. So, why should you start thinking of selling with every 1000-2000 point decline in an imaginary index?
4. If you are holding good businesses in your portfolio, then keep holding them. 
5. Use this decline to add to your holdings. Sure, the prices may go down 10% from here, but it may also go up 20%. I know of people who sold stocks around 18000 (Sensex) thinking that the market was getting overvalued. Unfortunately, for them, the index is still not back to that level. It may get there or it may not. Stop playing this game of prediction. It is a game no one can win.
6. When you invest you need to have a strategy. One which identifies when to buy, what to buy, when to sell and how much of cash to keep in your portfolio. If you have a proper strategy that answers all these questions, then just follow it. Please keep some cash aside to use for better opportunities that may come in the near future.

It has been best said by Warren Buffet, "The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values."

Happy Investing.