The US government shutdown has finally ended and it was interesting to see that the S&P 500 was actually up by about 3% in October which roughly overlaps the time this circus lasted.
I was watching these events closely from an investment perspective because I have a lot more money invested in the American markets right now than I have in India. That these events didn’t affect the stock market isn’t that big a deal, but I was surprised to see that the market actually went up by 3%.
Ignoring this event and doing nothing would have been the best bet as far as I am concerned, and this is what I did. However, this made me wonder what would have happened if I hadn’t done anything at all this year?
My portfolio is down 1.5% for the year, and the S&P is up about 20% for the year so I have obviously done quite badly. It is just a small consolation that I was up 60% last year when the S&P was up about 13%.
All of my losses stem from Put options, and a simple calculation showed that I would have been up about 20% had I not traded in any Options at all.
Next, I looked at the three sales I made during the year, and found that had I continued to hold on to those shares, they would have added two percentage points to my gains. So, in all, if I hadn’t done anything I would have been up about 22% for the year.
Now, hindsight is a wonderful thing, but what lessons can I learn from this that can be practically applied.
Since I do use some sort of valuation when I buy a share – I only sell them when they seem overpriced, and in these cases it did feel that the shares were overpriced. The market says I’m wrong, but only by a little and I can live with that.
The Put Options are more interesting to me because of the allure they hold. It is easy to make money when the market is up, and everyone is doing it anyway, but making money when the market is down is far more sexier and holds a lot more appeal than going long.
It is as if the money you make by going short is more valuable than the money you make by being long and I would say that the good feeling that comes along with it certainly makes it feel like it.
The great difficulty in this is that not only do you have to be right about price, you have to be right about timing, and it is entirely useless if you get just one out of the two.
Now, the other aspect of doing nothing is not buying. I have not been buying as much as I did when there is panic in the markets and I think by and large time will show that it is the right strategy. However not doing anything is much harder than it actually sounds.
I get tempted by a new share every other week but I just bite my lip and wait. I have not completely stopped buying to hedge against the scenario where I am wrong and the markets rise a lot more before they fall.
This past year has taught me to not seek the excitement of shorts and continue to restrain myself when shares present them to me in seemingly comfortable markets because I’m sure deals will present themselves later. There is a lot of value in doing nothing, the hard part is to recognize this and then being patient about it.
This is an interesting topic and is something that I’ve given some thought to myself. I won’t restrict myself to the question about the second stream of income, but share some things about this topic that people who have taken this course have told me about, and I feel are important as well.
You need to save to invest
Let’s start with the basics, which I find is hard for a lot of people to do. If you have credit card payments due or have a big car loan or home loan that has an installment due every month then you are probably not saving very much money. If you aren’t saving a lot of money then you can’t invest anything to create a second stream of income in the first place.
You can only save money when your expenses are low, so I believe low expenses are the foundation of this attempt.
Not all earned money is equal
Since we are so used to paying taxes, often we don’t realize how big of a piece the government actually takes. So when you save money that’s actually worth a lot more than making that much extra money in salary because you don’t pay taxes on savings.
Similarly taxes on mutual fund capital gains and FMPs are less than the marginal rate so any income you get from that source is worth a lot more than your salary.
Lastly, when you do a calculation of how much your startup income should be to replace your salary income, consider your take home pay, and not your gross salary. From your take home pay deduct your savings, and usually this should be a comforting number because it is a lot less than simply dividing your gross salary by 12 and hoping your new enterprise makes that much in the very first year itself.
Be prepared to dip into your savings
I don’t think it is practical to think that you can save enough to completely replace your salary at such a young age so if you want to take a sabbatical of sorts to try out your hand in a new venture then be prepared to dip in your savings.
This means that some part (a significant one I would imagine) of your money is invested in assets that you can liquidate easily. If you are invested in FMPs, infrastructure bonds, PPF, NSCs or any other investment which has a long gestation period then you have to ensure that you have other assets that allow you to liquidate them if you need money. Here, you have to remember what instruments truly have a lock in period. Most tax free bonds have a 10 or 15 year time frame for redemption but they trade on the market so if you needed the money you could sell them off fairly easily.
Tax free and tax saving instruments
Don’t invest a lot in tax free or tax saving instruments. For example, tax free bonds are a great source of tax free income when you are in the 30% tax bracket but you don’t need that if you aren’t going to be hitting that level every year, so you don’t need to give up compounding for that (tax free bonds pay out yearly interest that you can’t reinvest in the same thing). A fixed deposit that compounds and reinvests might be a much better option.
Equity investments
Due to the volatile nature of Indian equities, they can make for a great investment if you take advantage of the crashes and stick to an investment plan. Although your first instinct would be to avoid such a volatile investment option since you need money in a medium to short run, I think it is best to have exposure to equities even with this type of a need.
Work part time before you quit completely
I have a few friends who have taken the entrepreneurial route and it is a mix of people who just left their jobs as well as people who worked part time, made some money on the side and then quit their jobs. It’s not always possible to work part time on the side but wherever possible that is definitely the better option. You get to experiment with what you are doing without risking a lot and you get a fair sense of whether it will work or not and then the plunge full time is a lot less stressful. That you already have cash coming in is a tremendously huge plus.
Conclusion
I feel a good strategy to approach this situation is to save a lot of money, make sure your credit cards are zero and you don’t have any other big EMIs due every month and then invest the rest in medium term instruments that have good liquidity and generate a decent return. There are not many instruments that fit this bill and a mix of dynamic bond funds, equity mutual funds and the good old fixed deposits will help you go a long way in achieving this.
Finally, I know a lot of readers fit this bill as well, and I would request them to leave comments here and share their insights on how they managed money when they switched from full time employment to their own venture.