I met someone the other day whose big regret was not moving money from a fixed deposit into stocks in 2020. And in the process losing out on a massive profit opportunity. I am sure you too know many people who carry this regret. Perhaps, you too?
Looking back into this episode does offer some instructive lessons. We did explore this somewhat in an earlier edition of Contramoney–The art of gambling: Will Perma Bulls get lucky again this year?.
Today, let’s address this question in the context of the current situation. And perhaps draw up some principles on how one can make such decisions in the future. Let’s work through this bottom-up.
First, is there a reason to exit your FDs today?
Interestingly, given the competition for deposits, yields on term deposits–including fixed deposits–are lucrative relative to what they have been in recent years. In fact, even on an absolute basis, they are quite attractive, especially for someone who needs a fixed source of income. So, typically, if you are generally an FD investor, then these would count as good times for you.
But let’s talk about why stocks are a pull for your FD money.
This is easy to explain in the current context. It’s called FOMO–the fear of missing out. I am serious. In support, I offer the ironclad Warren Buffett rule: Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.
You see, stocks are hot today. Valuations in the broader market (but not the large caps) are totally out of whack with historical averages. And yet, money is pouring in like never before–being greedy when others are greedy. This approach almost guarantees (unless you luck out) one of two outcomes.
One: worse returns than you expected since the hype has already taken prices sky high. Two: negative returns, if the extremely high expectations of either the company results or of huge money inflows in the markets fall short.
So, generally speaking, even if you are a seasoned stock market investor, this is the time to be cautious with how you deploy fresh funds into the market.
Given this, the question that needs to be asked as a counter is this: Should one shift from a market that is relatively lucrative to one that looks like it could either take a knock or offer suboptimal returns?
That said, there’s a higher level ingredient that is required in the mix for a sensible answer: Are you a FD investor? Or are you a stock investor?
Now, of course, there are people at extreme ends of this spectrum. One set just cannot take any risk, no matter what–i.e., the pure FD investor (perhaps pensioners, with limited corpus). They benefit from higher interest rates and should stay put. The other cohort–i.e., the stock investor–cannot take enough risk. We don’t need to offer them any advice. They will continue to lift trading volumes to all-time highs.
The answer gets muddied if you are not at the extreme ends of this spectrum. Let’s take the example of an FD investor who has an appetite for risk. Where does this “risk money”–i.e. money meant for, say, stocks–sit today?
If you are in stocks already, then you still need to act to ensure you lock in your stock market gains.
If you are short on your allocation, and some of the risk money is still to be invested, then you need to approach this cautiously. Consider buying stocks of well-managed companies with durable franchises that are presently not the focus of greed. This simple strategy should do you well in the years to come.
Or if you lack the competence to pick stocks, stick to a well-diversified equity fund (I believe they are called Flexicaps these days).
If you are excessively exposed to risk, then there’s no better time than now to set that right. How should you do this? I’ve explained about that in this earlier edition.
This takes us to the last, and perhaps most critical, part of this bottom-up answer–what’s your optimal asset allocation? How do you know to what extent you should be in FDs or in stocks?
In my experience, many fail to generate wealth because of poor investment choices. However, even more perhaps, they often make the right choices but allocate poorly. And this second part is often the bigger cause of unrealised family fortunes.
To me, good asset allocation nudges one to invest across asset classes in a manner that: a) maximises the chances of attaining their life goals; b) optimises both risk and return to suit to the profile of the person; and c) by setting up a broad framework for allocating, effectively reduces the chance of them making large, potentially life-changing, whimsical decisions.
This has to do with things like how much to allocate to which asset class, the position size of each stock, and how an individual’s wealth is doing, say, in terms of units of gold. All ideas that are usually alien to people.
This last question–“how much to invest and where?”–is perhaps the most critical one, and which you cannot afford to get wrong.
If you have this prism for sensible decision-making already in place, then the answer to whether you should move your FD money to stocks should be crystal clear. If not, you could still go ahead and decide based on the relative attractiveness of the opportunity. But then, you would be possibly turning away from an even bigger opportunity–the chance to create solid wealth, sensibly.
Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.
You should always consult your personal investment advisor/wealth manager before making any decisions.