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Photo: Mint

Opinion | The key to dealing with good and bad times is to prepare for what’s coming

Having a real plan means deciding in advance the changes in asset allocation

Akbar once asked Birbal to paint a wall. “Your composition should be something that will make me happy when I am very sad and make me sad when I am very happy." Birbal thought hard and painted this quote on the wall, “Yeh waqt bhi guzar jayega (this time too shall pass)". Investors would also do well to pay heed to this advice. All too often, they get carried away when times are either too good or too bad. They forget that nothing lasts forever. “Nothing goes in one direction forever. Trees don’t grow to the sky. Few things go to zero. And there’s little that’s as dangerous for investor health as insistence on extrapolating today’s events into the future," said Howard Marks, co-chairman of Oaktree Capital Management, the largest investor in distressed securities worldwide.

Just like day follows night and winter follows fall; in businesses, markets and economy, a boom follows a bust and vice-versa. So when either of them happens, it should not come as a surprise. Booms and busts are part of an investor’s life. They are a result of excesses caused by human behaviour. We cannot wish either of them away as long as humans are humans. So what can we do?

Assuming one will be able to exit all investments and sit in safe assets before a bust is futile. Similarly, one can’t always catch the bottom on the way down. But that doesn’t mean one can’t do anything about it. One can prepare.

Warren Buffet has talked about Noah’s rule in one of his letters to Berkshire Hathaway shareholders , “Predicting rain doesn’t count, building arks does." We all know about Noah’s biblical tale. God told Noah that he planned to bring a flood and destroy everyone on earth. Noah was told to build an ark for his family and a pair of every animal on the planet. Noah did exactly that even though he was ridiculed by everyone else. When the flood came, the ark came to Noah, his family and the animals’ rescue.

Even if we know and can predict adversity, it is of no use if we don’t prepare for it. Preparing for a bust or a recession means, one, keeping an asset allocation which doesn’t affect your lifestyle and your sleep and, two, having a plan ready about what to do next. Most of us fail to do this in earnest. We wake up to build our arks when the flood arrives, only to find that we have neither the time nor the resources to do it.

When equity markets are doing well, allocation to equities goes up. But we throw caution to the wind and let it remain so. If one maintains the discipline in good times, one would not be as affected in bad times.

“Buy when there’s blood in the streets," Baron Rothschild, who made a fortune buying stocks in the panic that followed the Battle of Waterloo against Napoleon, is supposed to have said. It is one quote you will hear the most when markets crash. But the original quote is believed to be, “Buy when there’s blood in the streets, even if the blood is your own."

We all think we know what to do when the market crashes, but when it actually happens, we feel paralyzed because of the damage caused to our own portfolios. “When the time comes to buy, you won’t want to," said Walter Deemer, veteran analyst and author. All of a sudden, we realize that our plan “to buy more when the market crashes" was never really a plan. Similarly, on the way up, when markets become irrationally exuberant, we become greedy and forget that we are supposed to trim equity allocation.

At their extremes, markets cause us to go into a shock while going down and into a drunken stupor on the way up. In either condition, we are not in a position to think clearly or decide.

Having a real plan would involve deciding in advance the changes in asset allocation and how those changes would be implemented. Whether one will invest more in equities gradually or in one go? Invest in index funds, actively managed funds or stocks? On the way up, what will be the trigger to reduce allocation to equities? All these decisions have to be thought through and decided in advance. One can argue that the situation may demand improvisation. But then not having any plan means having to think about what to do at a time when one has the least amount of mental fortitude for the task.

Treating both good and bad times with equanimity and taking advantage of them requires two things. One, remember that they follow each other. Two, always prepare for what’s coming.

Jitendra Chawla, CFA, is vice-president, investment solutions at a private wealth division of a multinational bank

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