Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

Creativity Is a Process, Not an Event

Creative thinking requires our brains to make connections between seemingly unrelated ideas. Is this a skill that we are born with or one that we develop through practice?

 

One of the most critical components is how you view your talents internally. More specifically, your creative skills are largely determined by whether you approach the creative process with a fixed mindset or a growth mindset.

 

The basic idea is that when we use a fixed mindset we approach tasks as if our talents and abilities are fixed and unchanging. In a growth mindset, however, we believe that our abilities can be improved with effort and practice. Interestingly, we can easily nudge ourselves in one direction or another based on how we talk about and praise our efforts.

 

Creativity is a process, not an event. It's not just a eureka moment. You have to work through mental barriers and internal blocks. You have to commit to practicing your craft deliberately. And you have to stick with the process for years, perhaps even decades, in order to see your creative genius blossom.

https://jamesclear.com/creative-thinking

 

AI for drug discovery

A new Alphabet company, Isomorphic, will use artificial intelligence methods for drug discovery, Google’s parent company announced. It’ll build off of the work done by DeepMind, another Alphabet subsidiary that has done groundbreaking work using AI to predict the structure of proteins.

 

For years, experts have pointed to AI as a way to make it faster and cheaper to find new medications to treat various conditions. AI could help scan through databases of potential molecules to find some that best fit a particular biological target, for example, or to fine-tune proposed compounds. Hundreds of millions of dollars have been invested in companies building AI tools over the past two years.

 

Isomorphic will try to build models that can predict how drugs will interact with the body, Hassabis told Stat News. It could leverage DeepMind’s work on protein structure to figure out how multiple proteins might interact with each other. The company may not develop its own drugs but instead sell its models. It will focus on developing partnerships with pharmaceutical companies.

https://www.theverge.com/2021/11/4/22763535/google-alphabet-drug-discovery-deepmind-ai

 

Smell as a repository of old memories

When you see, hear, touch, or taste something, that sensory information first heads to the thalamus, which acts as your brain's relay station. The thalamus then sends that information to the relevant brain areas, including the hippocampus, which is responsible for memory, and the amygdala, which does the emotional processing.

 

But with smells, it's different. Scents bypass the thalamus and go straight to the brain's smell center, known as the olfactory bulb. The olfactory bulb is directly connected to the amygdala and hippocampus, which might explain why the smell of something can so immediately trigger a detailed memory or even intense emotion.

 

Some think it goes back to the way we evolved: Smell is one of the most rudimentary senses with roots in the way single-celled organisms interact with the chemicals around them, so it has the longest evolutionary history. This also might explain why we have at least 1,000 different types of smell receptors but only four types of light sensors and about four types of receptors for touch.

https://www.discovery.com/science/Why-Smells-Trigger-Such-Vivid-Memories

 

Diversify before concentrating your focus

In Wang’s most recent analysis, he found that artists and scientists tend to experiment with diverse styles or topics before their hot streak begins. This period of exploration is followed by a period of creatively productive focus. “Our data shows that people ought to explore a bunch of things at work, deliberate about the best fit for their skills, and then exploit what they’ve learned,” Wang said. This precise sequence—exploration, followed by exploitation—was the single best predictor of the onset of a hot streak.

 

The research suggests something fundamentally hopeful: that periods of failure can be periods of growth, but only if we understand when to shift our work from exploration to exploitation. If you look around you at this very moment, you will see people in your field who seem wayward and unfocused, and you might assume they’ll always be that way. You will also see people in your field who seem extremely focused and highly successful, and you might make the same assumption. But Wang’s paper asks us to consider the possibility that many of today’s wanderers are also tomorrow’s superstars, just a few months or years away from their own personal hot streak. Periods of exploration can be like winter farming; nothing is visibly growing, but a subterranean process is at work and will in time yield a bounty.

 

Wang’s research seems to back up that claim. The central paradox of the explore-exploit sequence is that hot streaks are examples of specialization, but specialization itself doesn’t lead to hot streaks. Today’s best exploiters were yesterday’s best explorers.

https://www.theatlantic.com/ideas/archive/2021/11/hot-streaks-in-your-career-dont-happen-by-accident/620514/

 

Turning industrial emissions to animal feed

Chinese researchers said they have developed the technology to turn industrial emissions into animal feed at scale, a move that could cut the country’s dependence on imported raw materials such as soybeans. 

 

The technology involves synthesizing industrial exhaust containing carbon monoxide, carbon dioxide and nitrogen into proteins using Clostridium autoethanogenum, a bacterium used to make ethanol.

 

If China can produce 10 million tons of synthetic protein using the new technology, that would be equivalent to about 28 million tons of soybean imports, the researchers noted. Producing synthetic proteins for animal feed at a large scale would also help China in its decarbonization program.

https://www.bloomberg.com/news/articles/2021-11-04/chinese-scientists-say-they-can-turn-emissions-into-animal-food

The IPO Frenzy

 

The IPO market in India is sizzling. Some notable IPOs that are open now or was issued in the recent past. But what has caught the imagination of the investors are the new-age tech startups. The notable ones are as follows:

• One 97 Communications (Paytm)
• PB Fintech (Policybazar)
• Fino Payments Bank
• FSN Ecommerce (Nykaa)
• CarTrade
• Zomato

Let me state it upfront. I believe that the Indian new-age IPO market is in a bubble. A big one at that. And promoters are rushing head over heels to bring their loss-making enterprises to market to secure their own futures. No one is questioning how much of the IPO is an OFS (offer for sale) where the existing promoters and investors are dumping their own holdings onto public shareholders.

But are they to blame? Why are investors ready to pay 30-80 times sales for companies which are not profitable, neither have a path to profitability or where competition is so stiff that whatever meagre profits are being earned can disappear in an instant from external competition or regulation?

The answer to that probably lies in the fabulous run of big tech (FAANG etc) in the US. Indians have seen the phenomenal performance of Amazon, Facebook, Google etc and feel that this time they can make money from such new-age tech stocks. After all, wasn’t Amazon loss-making for a very very long time?

There are two fundamental problems with the Amazon example. And nearly always, Amazon is the example 😊

1. Amazon wasn’t doing very well on their retail front but AWS, which was something no one knew would come along, came in and started spewing cash with a vengeance. That cash is what helped the stock reach the commanding heights it has done today.
2. Amazon is and always was a dominant global player which could use its scale to reduce its cost. It built its business on being a low-cost, consumer-friendly operation that passed on a large part of its scale-gains back to the customer thereby creating a virtuous cycle. People got low prices because of Amazon’s scale and more people bought more goods on the platform which in turn increased its scale. But even this is not enough, because a lot of other players did the same in the offline world – like Costco, Walmart etc. Walmart tried replicating the same in the online world as well but wasn’t very successful.

Look at the Big Tech stocks – can you think of normal lives without Google (search, youtube, Gmail, maps, translate)? Is any of India’s tech companies as dominant in its space as Facebook or WhatsApp? Or have fierce loyalty as Apple? Do we have a Netflix equivalent or a Tesla? Nearly all the US Big Tech have global dominance.

When you dissect each business that is IPOing in India today, you realize that none of these businesses is new. They have been in business for a number of years and are still struggling. Their claim-to-fame is the media PR, which is probably paid for by the companies themselves, and mainly deals with how much money one has raised from its investors. Can you live if Paytm is down for a day? Of course, you can. Most probably you won’t even miss it. Can Zomato be profitable if labour regulations harden or if (and when) restaurants start their own ordering app?

And in the typical incentive-caused bias of media and sell-side analysts come in. Nobody wants to put their neck out and say that these IPOs are priced ludicrously. Investors are happy if they get an allotment and get an initial pop. No one is looking to buy and hold these businesses for the next 10 years. In fact, for a lot of promoters, bringing their company to market is the end-game and not really a step along the long and arduous journey of building an institution.

I am not someone who obsesses over valuations. I think good things are always expensive. But paying a scaringly high price for buying something where the promoters are willingly selling and which have a questionable business model with a very hard-to-fathom path to long term profitability scares the hell out of me.

Since I come from a middle-class background and believe that capital is sacred and irreplaceable, I am very sceptical about the entire IPO scenario in India today. The bubble is there, it is acknowledged in hushed tones but no one wants to leave the party. For the simple reason that no one knows if the party s nearing its end or just beginning. I am not applying for any of these overpriced and overhyped IPOs as of now. I am ready to forego of listing gains and looking foolish (in reality, can’t actually be sure if I am foolish or not!!). 

But let this be my caution to you. Participate in this frenzy only if you know what you are doing.

This article appeared in The Economic Times

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

1. The art of not selling

“Of our most costly mistakes over the years, almost all have been sell decisions. The mistake, in virtually every instance, has been selling too soon. Reflecting on these mistakes gave rise to this letter, and its title, “The Art of (Not) Selling.”

Taking a step back, our investment philosophy involves concentrating our capital in a small number of what we believe to be growing and competitively advantaged businesses. These kinds of businesses are rare and are only periodically available for purchase at attractive valuations. With that in mind, we do our best to hold on for the long term, so that our capital may compound as the businesses grow.

Holding on means resisting the temptations to sell — and there are many. We tune out politics and macroeconomics. To the surprise of many, neither valuation nor price targets play a role in our sell decisions.

To be clear, there may be times when we believe it is appropriate to sell. In these instances, it is typically because of an adverse change in the business itself.

https://www.akrecapital.com/the-art-of-not-selling/

 

2. The Scientific Argument for Mastering One Thing at a Time

If you want to master multiple habits and stick to them for good, then you need to figure out how to be consistent. Research has shown that you are 2x to 3x more likely to stick with your habits if you make a specific plan for when, where, and how you will perform the behavior. Researchers found that people who filled out this sentence were 2x to 3x more likely to actually exercise compared to a control group who did not make plans for their future behavior. Psychologists call these specific plans “implementation intentions” because they state when, where, and how you intend to implement a particular behavior.

 

Developing a specific plan for when, where, and how you will stick to a new habit will dramatically increase the odds that you will actually follow through, but only if you focus on one thing.

 

Follow-up research has discovered implementation intentions only work when you focus on one thing at a time. In fact, researchers found that people who tried to accomplish multiple goals were less committed and less likely to succeed than those who focused on a single goal.

 

The best way to change your entire life is by not changing your entire life. Instead, it is best to focus on one specific habit, work on it until you master it, and make it an automatic part of your daily life. Then, repeat the process for the next habit.

https://jamesclear.com/master-one-thing

 

3. The IPO mania has begun

It's one thing to invest in a loss-making company but quite another to invest in a business that has never made money. Not just that, one could reasonably argue that in some of these businesses, it is unproven on a global scale whether money can be made at all. Food delivery and cab-hailing are perfect examples of this. One particular company may be chronically unprofitable and that's pretty bad but if no one in the world has ever made profits in a particular line of business, then you have to start wondering if that business is a business at all.

 

The classic logic that is always given for investing in such businesses is that the losses are a price to be paid for fast growth and for capturing enormous market shares. There are many dominant Internet businesses today whose past is said to prove this point. Google, Facebook, Amazon are all perfect examples. However, the key here is that it takes growth - scorching growth - to justify the losses. Is that kind of growth visible in the big Indian names here? Paytm, which is apparently going to come out with the largest Indian IPO ever, has now had a stagnant topline for three years! Its net income for the March 2021 year-end is actually lower than that for the March 2018 year-end.

 

In fact, when one looks at Nykaa, one realises that never having made any profits actually works well for such companies at the time of the IPO. Nykaa has had the misfortune of having actually made some small amounts of profits here and there. This means that investors can calculate the P/E and see what value they are getting. Perpetual lossmakers like Zomato and Paytm are, in that sense, lucky that they have never made any profits, so no P/E can be calculated, and therefore, all that is there is a hot story about the future, unsullied by any whiff of reality.

https://www.valueresearchonline.com/stories/49929/a-new-hype-train-sets-off/

 

4. Internal vs external benchmarks

If you measure your career solely relative to an external benchmark – you’re on the neverending path of feeling inadequate, incompetent, and poor. Nothing you do will ever feel that great because someone is always smarter than you, more popular than you, better looking than you, getting richer faster than you, and making sure you know about it.

 

It’s not until you focus on internal benchmarks and see how far you’ve come, relative to where you began – the gap between today and your own cost basis – that you have a good view of where you stand and what you’ve accomplished.

 

Almost everything looks better from the outside. When you’re keenly aware of your own struggles but blind to others’, it’s easy to assume you’re missing some skill or secret that others have. Few things are as awful as chasing something you eventually realize you never actually wanted.

https://www.collaborativefund.com/blog/internal-vs-external-benchmarks/

 

5. Jeff Bezos' management principles

“Amazon has no secret management principles.” Jeff talks about them all the time at “all-hands” meetings. He explains them in press interviews that can be viewed on the internet, and they are listed at the bottom of every press release. But, I explained, you have to live by them all of the time, and most businesses are unwilling or unable to do so.

 

The most important is customer obsession. In his words, too many companies focus on their competitors and not on their customers.

 

The second principle is constant invention and innovation. As noted above, invention is closely linked to customer satisfaction. Constantly invent and apply technologies to solve problems and build new businesses.

 

The third principle is operational excellence.

 

Think long-term is the fourth touchstone, whether in launching new businesses or investing in new technologies.

 

Perhaps Jeff’s overriding principle, which is not on Amazon’s formal list, is his abiding optimism of the future and how we are only in Day 1.

https://www.fastcompany.com/90691896/what-ive-learned-from-watching-jeff-bezos-make-decisions-up-close

When in doubt, go back to first principles

 

Whenever you are in doubt of what to do with your investments, or scared of the market fall, or fearful of the market topping out, just ask yourself these two questions.

1) What is my investment objective?

2) What is my investment time horizon?

I have found that if you keep asking yourself these questions during moments of doubt, there is a lot of clarity that emerges. Last few days, the markets have seen some correction and the narrative amongst people has changed. 

The last few days the rocket emojis and the “I-told-you-so” tweets & WhatsApp messages have gone missing and a large number of vocal participants, are observing a deathly silence. All this is because the fear of money is real. Prospect theory or loss-aversion theory is at play here. It is far more painful to lose money than to gain an equal sum. 

So, when you have a fall in the prices of shares you hold, there is a real fear. The fear of losing the gains. Or the fear of losing your capital. That is when the answers to the two questions help you get centered back to what you really want. If you are investing because you want to build up a retirement nest egg or if your time horizon is 10 years or more then reacting to every 10% rise and fall is meaningless.

For example, here are my answers to those questions.

1) My investment objective is to generate an absolute positive return without losing capital permanently. The additional goal is to generate 10x in 10 years by compounding at a rate of 26%. Now that may seem low with respect to how the market has turned out in the last year, but I know if I am able to do this consistently over a 10-year cycle, I will be okay.

2) I don’t need the money in the near foreseeable future, so the main objective is to be able to compound the capital for as long as possible at as high a rate as possible without taking the risk of permanent capital erosion. So, it is safe to say, that my time horizon is 20+ years.

Every time I clarify to myself these answers, the short-term urge to do “activity” reduces. It pushes me to look for stock ideas or investment strategies that align with my objective and time frame. This is also why I don’t do very short-term trading or use quant systems to do so. Because it gels with neither my objective nor my time horizon.

Weekend Reading

 

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

1. Why do people believe in conspiracy theories so easily?

Information that is interesting and attention-grabbing is easier to mentally process than information that is boring (such as realistic yet not particularly exciting information revealing that, on most days, politicians simply work on new legislation in their offices). Greater ease of processing, or fluency, has been found to promote truth judgments. This fluency heuristic likely exists because, in daily life, information that ‘feels right’ in this way is often true (eg, birds fly; fish swim). But the side-effect is that, when false information is easy to process, people more readily infer that the information is correct.

 

Additionally, the intense emotions triggered by conspiracy theories might suppress people’s capacity to think rationally about them. Emotions are part of a system within the human mind that produces snap judgments, while slower, more analytic thought is required for scepticism about conspiracy theories. The combination of fluency and suppression of rationality could promote the belief that there is truth in an entertaining conspiracy theory.

https://psyche.co/ideas/how-conspiracy-theories-bypass-peoples-rationality

 

2. Writing as a means of generating new ideas

The best you can do is figure out what sort of work you have an "aptitude" for, so that whatever intelligence you were born with will at least be put to the best use, and then work as hard as you can at it. Whereas if intelligence isn't what matters, but only one of several ingredients in what does, and many of those aren't inborn, things get more interesting. You have a lot more control, but the problem of how to arrange your life becomes that much more complicated.

 

So what are the other ingredients in having new ideas? The fact that I can even ask this question proves the point I raised earlier — that society hasn't assimilated the fact that it's this and not intelligence that matters. Otherwise we'd all know the answers to such a fundamental question.

 

One of the most surprising ingredients in having new ideas is writing ability. There's a class of new ideas that are best discovered by writing essays and books. And that "by" is deliberate: you don't think of the ideas first, and then merely write them down. There is a kind of thinking that one does by writing, and if you're clumsy at writing, or don't enjoy doing it, that will get in your way if you try to do this kind of thinking.

http://paulgraham.com/smart.html

 

3. Climate change is already here

Many people still think of climate change as a phenomenon that we will only face in the distant future. Perhaps that’s partly because climate change projections about rising temperatures and extreme weather events are tied to future dates: 2030, 2050, or 2100, for instance.

 

But it’s important to realise that we already are experiencing climate change, and have done so for some time now. Over the past century, global temperatures have increased by approximately 1°C. Sea level rise is already starting to affect certain low-lying coastal communities. The world is experiencing more frequent and intense extreme climate events.

 

These shifts have an impact on agriculture and tourism, but more importantly demonstrate that climate change is having an effect on the natural environment. These shifts in timing cannot continue indefinitely. Plants and animals have thresholds beyond which the stresses of climate change will result in at least local extinction.

https://theconversation.com/climate-change-has-already-hit-southern-africa-heres-how-we-know-169062

 

 

4. Starting from scratch is usually a bad idea

Too often, we assume innovative ideas and meaningful changes require a blank slate. When business projects fail, we say things like, “Let's go back to the drawing board.” When we consider the habits we would like to change, we think, “I just need a fresh start.” However, creative progress is rarely the result of throwing out all previous ideas and innovations and completely re-imagining of the world.

 

We are mostly blind to the remarkable interconnectedness of things. This is important to understand because in a complex world it is hard to see which forces are working for you as well as which forces are working against you.

 

When you are dealing with a complex problem, it is usually better to build upon what already works. Any idea that is currently working has passed a lot of tests. Old ideas are a secret weapon because they have already managed to survive in a complex world.

 

Iterate, don't originate.

https://jamesclear.com/dont-start-from-scratch

 

5. Stop reading the news

Most of what you read online today is pointless. It’s not important to living a good life. It’s not going to help you make better decisions. It’s not going to help you understand the world. It’s not dense with information. It’s not going to help you develop deep and meaningful connections with the people around you.

 

Like a drug, the news is addictive. Not only does it alter your mood, but it keeps you wanting more. Once you start consuming news, it’s hard to stop. The hotels, transportation, and ticketing systems in Disney World are all designed to keep you within the theme park rather than sightseeing elsewhere in Orlando. Similarly, once you’re on Facebook, it does everything possible, short of taking over your computer to prevent you from leaving. But while platforms like Facebook play a role in our excessive media consumption, we are not innocent. Far from it. We want to be well informed. (More accurately, we want to appear to be well informed.) And this is the very weakness that gets manipulated.

https://fs.blog/2013/12/stop-reading-news/

Weekend Reading

 

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

Maldives creates a floating city

The atoll nation of Maldives is creating an innovative floating city that mitigates the effects of climate change and stays on top of rising sea levels.

Such a development is particularly vital for countries such as Maldives – an archipelago of 25 low-lying coral atolls in the Indian Ocean that is also the lowest-lying nation in the world.

 

More than 80% of the country’s land area lies at less than one metre above sea level – meaning rising sea levels and coastal erosion pose a threat to its very existence.

 

Maldives thrives on tourism and the same coral reefs that attract holiday makers also provide the inspiration for much of the development. The hexagon-shaped floating segments are, in part, modelled on the distinctive geometry of local coral.

https://www.weforum.org/agenda/2021/05/maldives-floating-city-climate-change

 

The dream of animal-to-human transplants or xenotransplantation is a few steps closer to reality

Scientists temporarily attached a pig’s kidney to a human body and watched it begin to work, a small step in the decades-long quest to one day use animal organs for life-saving transplants.

 

Pigs have been the most recent research focus to address the organ shortage, but among the hurdles: A sugar in pig cells, foreign to the human body, causes immediate organ rejection. The kidney for this experiment came from a gene-edited animal, engineered to eliminate that sugar and avoid an immune system attack.

 

Surgeons attached the pig kidney to a pair of large blood vessels outside the body of a deceased recipient so they could observe it for two days. The kidney did what it was supposed to do — filter waste and produce urine — and didn’t trigger rejection.

https://apnews.com/article/animal-human-organ-transplants-d85675ea17379e93201fc16b18577c35

 

When in doubt, copy

From infancy, we learn by copying others. It’s also how we navigate uncertainty throughout our lives. Copying is what people have always done because it’s not only easy, it’s effective. If it weren’t, we wouldn’t still be doing it because we wouldn’t be here.

 

Copying is so effective that all sorts of animals, even fishes, copy each other’s behavior in order to adapt. When real people rather than computers play games, they don’t doggedly follow tit-for-tat or some other mechanical algorithm. They copy other people’s winning strategies.

 

 Copying is pretty safe, too, since at least you will be doing something that has succeeded to the point of becoming visible to you. The easiest thing to do, even by accident, is to copy something popular and successful. In the social world, popularity is success, so you’ll be doing fine.

https://thereader.mitpress.mit.edu/when-in-doubt-copy

 

The challenges of the worker in a gig economy

Platform work is precarious by nature. Even though more than half of all gig workers rely on it for most of their income, 40% of them make less than minimum wage. But it’s not just about the money. It’s about fragility and insecurity. Day to day, gig workers worry about their health, their safety, and whether or not they’ll make enough to cover their costs. More than 60% want to quit within a year.

 

Digitally-mediated gig work has surged over the past decade. The International Labor Organization counted 489 active ride-hailing and delivery platforms worldwide in 2020, ten times the number that existed in 2010. The fluid nature of the workforce means there are few consistent estimates to how many people are now engaged in this kind of labor, but some researchers believe that as much as 10% of the global workforce now engages in some kind of gig work.

 

Gig work is worse for women, who earn less on the platforms than men. Meanwhile, even though the biggest gig platforms are disrupting the global workforce, few of these companies have shown they can sustainably make a profit, relying instead on investors to fuel their growth.

https://restofworld.org/2021/the-global-gig-workers/

 

The forgotten scam

Abdul Karim Telgi, the kingpin of a multi-crore counterfeit stamp paper scam, began as a furniture sales executive with a salary of Rs 3,800 in Mumbai. It is alleged that between 1993 and 2002, he cultivated officers in the government security press in Nashik and purchased machinery at government auctions to print counterfeit stamp papers. He then sold them at a discount to bulk purchasers such as banks, insurance firms and stock brokerage firms.

 

Investigators estimated Telgi’s personal worth at his prime exceeded a hundred crores and he owned about 36 properties across the country.

 

Telgi allegedly bribed his way to run his scam. After the racket was uncovered, investigators searched for authorised vendors who had sent bogus papers to the stamp duty officials. Politicians and police were also accused of being complicit in the scam.

 

“Across 72 towns and 18 States and over a period of 10 years, the counterfeit stamp paper scam has dealt the Indian economy a shattering Rs 32,000-crore blow. The figure is official. Apprehensions are that it could be much higher,” Frontline magazine reported in November 2003. That’s the damage Telgi and people who helped him in the scam had done.

https://www.hindustantimes.com/india-news/abdul-karim-telgi-the-rise-and-fall-of-india-s-stamp-paper-scam-kingpin/story-Yzl341UmPkpHmBD8D533jJ.html

 

Building Financial Resilience

 

Every bull market hides within it the seeds of a bear market. The market, as a whole, is mean reverting. So, a bulk of what goes up tends to come down, if not fully but to a large extent, wiping out all the temporary gains made in the process. And in between this going up and coming down investors make their reputation and fortunes.

By virtue of running an advisory, I get an opportunity to speak to a large cross section of investors. On Monday, I was speaking to one such person. He was extremely concerned about investing at “such all time high market levels”. He said that it had taken him many years to get to where he is today financially and he did not want to risk a large part of his networth should there be a large market crash. What was left unsaid was that he was also loath to let go of the opportunity in case the market kept going up. So, here is a classical dilemma.

This conversation got me thinking in multiple directions – the role of asset allocation, the need for a robust investment philosophy suited to oneself and of course where one is in one’s financial journey. All of this led to “financial resilience”.

Covid has taught us that resilience is crucial – whether in one’s physical or mental health or finances. So, how does one build financial resilience? As my guru Charlie Munger says, “Invert, always invert”. So, inverting the question and asking myself, how do we make our finances more fragile?

Here are some ways. None of this is rocket science. It’s mostly common sense but if you get it right it helps tremendously in building your financial resilience and will help you in facing a market downturn whenever it comes. These are as true for individuals as for families and also companies.

No savings

If you are working for some time and haven’t built up an emergency fund or some cash reserves that can cover expenses for a few months, then your financial life is fragile. The first thing to do is to build up some cash reserves for the rainy day.

Inadequate insurance cover

The biggest unplanned expense tends to be a medical emergency. You need to have adequate medical insurance for self and family to cover the costs. Having to pay for expensive medical treatment could derail, and at times completely ruin, your financial plans. The worst is if it happens during a time when you are otherwise financially weak.

Large debts

100% of all bankruptcies happen due to inability to service a debt. Basically, if your income (P&L) does not support your debt (balance sheet), then you are in trouble.

If you are taking a loan to create an asset like a home, it is still understandable. But you should have sufficient cash savings and medical cover before you take a home loan.

Taking a loan for consumption should be a strictly no-no unless you have a reasonable amount of savings to cover for the loans. The problem is people who need loans for consumption are the ones who should not take it and those who can afford to take loans don’t because they already have the cash.

Similarly in a market crash, the stories you hear of people going bankrupt are those who are leveraged. You can at most lose a large part of your capital in stocks but in derivatives, if you don’t know what you are doing, you can get wiped out.

Single source of income

If you are dependent on a single source of income you are fragile. If your job or business is your sole source of income then you are financially fragile. Try to diversify your income stream. One reason I started investing was to be able to have another source of income over time. This is true for nearly all part-time investors who have a steady job or business. If you keep adding to your portfolio, over time it builds up into a nice source of income through dividends and interest payments

Inadequate diversification

A lot of people have all, or large parts, of their networth in one single asset class or asset. Indians primarily have a house which dominates their networth. Others may have gold or fixed deposits or equities. At an extreme case, having investments in only one company like that of a promoter of a business, is also a cause of fragility. Adequate diversification into multiple asset classes, especially ones which are not correlated, and assets may reduce your returns sometimes, but has the definite benefit of enhancing resilience.

 

The challenge with personal finance is that it is personal. It cannot be generalized. You have to take a hard look at your financial situation and decide what you want. And then work out a plan to solve for it. What you want will also change over time as you age and life situation and priorities change. That is the way it is.

The important thing to remember is that you need to stay in the game for the long term. Resilience is key. Plan on every plan not going according to plan.

This post appeared in CNBC.