Friday, July 3, 2015

Risk, Reward and (Old) Age

I love rewards.

If you don’t, you can stop reading right now.

The key thing about looking for rewards is - there is no such thing as a sure winner.

In other words, if you want to be rewarded for your investments, you have to take risks.

You probably know that equities offer high returns, even after accounting for the inflation that is chronic in India. This is quite unlike the crappy ‘safe’ investments like bank deposits, which yield negative returns after you account for taxes and inflation.

So, I’m not writing this to sell the equities story. I’m writing to ask you to consider how you deal with investing, aging, and retirement. Most investment advisers write out a prescription that says - “Patient approaching retirement - recommended he reduce his exposure to equities.” Many will even trot out a handy little formula that says “Percentage exposure to equities = 100- Age in years.”

These advisers, and their formula, are wrong: maths is maths, and fixed deposits give you negative real returns, whether you are retired or working. In fact, when you are working, salary or  professional income will usually keep up with price levels. When you are retired, this cost-of-living adjustment will have to come from investments, and ‘safe’ investments, like fixed deposits, don’t do that.

Then there is the question of how you view ‘retirement’. I view it as a time to  indulge in all my leisure activities - music, theater, travel, outdoor sports, and time with friends. It helps that I retired at 40, but I’m as passionate about these activities as I near 60, and intend to be for a long, long time. This stuff costs! And it costs more as you grow older.

Till a few years ago, I would stuff myself in the cheapest airline seat and fly off to Canada to walk a snowfield in spring. Today, my muscles cramp up on long flights, and I relish the ability to fly business class. When my wife and I moved into a stone cottage in the Himalayan foothills, I landscaped the garden myself, with a shovel and a spade; today, if I want a flower-bed to be shifted, I contract a village neighbour to do it. Two decades ago, we would spend the winter huddled in our sleeping bags next to the fireplace; today, we are drawing up plans for a modern heating system, double-glazing, and insulation in the roof.

You get the picture - 60, or even 70, is too young to give up one one’s passions, but they cost a lot more. If you want these rewards at the end of a productive life, you need the ‘risks’ of equity.
You notice I put the word risk in quote-marks - that is because the only risk is short-term volatility. In years of deep macro-economic crisis, as we saw in 2007-09, shares can take a huge beating, and if one is new to the game, one can be scared away for a long time - perhaps for ever. But, if one is investing for the long-term, for one’s 70s, 80s, and even 90s, this volatility is just the noise in a signal that produces a very healthy long-term growth in one’s net worth, in the region of 15% per annum. The only learning from the short-term beating is to have a couple of years’ worth of living expenses in low (negative) return investments - to tide over the time when shares are selling below their trend value.

So, here’s my formula - Indian equities should give you a minimum of 12% return over the mid- to long-term. Add 1% by way of dividend, and subtract 7-8% for inflation, so you’re talking 5-6% real return. This means that you can safely extract 5% of your portfolio value every year to meet your living needs, while preserving the real value of the equities for the years to follow.

If you began investing in equities early enough, or if you receive retirement benefits from your employer, you could well find at 60 that you don’t need to draw all of that 5%; maybe 2% is enough, or 3. What do you then?

This is a wonderful problem to have, and you have three choices: One is to spend more! The second is to succumb to the ‘safety’ trap, and convert some of your equities into fixed-income securities. The third is to climb further up the risk-reward curve!

I just exercised the last option.  I’m beginning to get bored of the predictable returns from my equity portfolio, and have begun to invest in start-up businesses. Risky business, these start-ups, but 30 years of equity investing gives you that stomach for risk. And, with a little bit of luck, I’ll be enthusiastic enough at 70 to enjoy the rewards this new journey into risk will bring.


  1. Such an useful read, thank you.

  2. Hey, Sheila! Was just thinking of you! I was reordering my bookshelf, and saw your book, with an inscription for Premi. I had already read my own copy.