Investment Objectives & Advice

Portfolio Management: Understand the move of Market P/E

Roughly the 5% fall in a week has shaken up lot of investors. Most of the people, who were being prudent and telling that stick to your asset allocations, are now getting call that “when you knew market is overpriced, why did you advise to invest in equity and not stay in Debt.” Let me know one of the known investor in India market Vijay Kedia “Only two people can predict the top & bottom of the market; God & a Liar“. For last few quarters, I have been telling all my people to respect their asset allocation as well as that markets are overpriced so stay vigilant and do not invest a lot in markets. I was getting calls to tell that see market is touching new highs and you are missing the profit opportunity. Now i am getting the similar reactions but reverse that why did i not push them to stay in fixed returns vs equity if i knew markets were overpriced. I wrote about P/E ranges to show the trend over last 18-20 years and how to use it (Read), also i spoke about how much equity you should hold is dependent on 4 parameters as Risk Appetite, Risk Capacity, Time Horizon & Market Valuations. Today, i will try to redeem myself and other investment enthusiast from such blames.

Can i interpret the market move for tomorrow or 3 months or 6 months? Answer is simple no. Can i comment on current scenario probably yes. It is similar to driving, If i am driving from Mumbai to Goa, Can i say how fast i will drive constantly? No, it depends on the traffic but during the journey based on the parameters like congestion, traffic signals etc i can say reasonable speed limits. Similarly looking at high P/E ratios i can not say that market is going to correct and stay out or market will grow faster invest more. Mathematically P/E just the ratio of two variables but in reality it is driven by whole lot of variables like investor sentiments, macro economic scenario, liquidity conditions, international markets, economic growth cycle etc. Still let’s stick to maths as it helps you simplify the complex things. The movement of P/E value has only three possible scenarios;

  1. The value of P/E increases, if the growth of price is faster than the growth of the earnings. If price is flat and earnings are decreasing (-ve growth) then also the P/E will increase or if the price is growing at +20% and earning are growing slowly at +10%
  2. The value of P/E is range bound, If the growth of price is similar to the growth of earnings. It can be either both are moving at +20% or both are falling at -10%. P/E value will still be similar
  3. The value of P/E decreases, When the growth of earning is faster than the growth of price. Earnings might grow at +20% which prices are growing at +10% or Earnings might stay flat while prices are falling by -10%

Since P/E in absolute terms do not tell us anything for concrete, why are we looking at it. let me tell you the words of the dean of value investing, “In the short run, market is like a voting machine, tallying up which firms are popular and unpopular. But in long run, The market is like weighing machine, assessing the substance of company.“So in all three circumstances One can not predict that what will be return in next few weeks, months, quarters or years. The only thing that can be said that P/E will try to move towards the theoretical value.

Let’s address the main question, what should we do? My boring suggestions as below:

  1. If the prices are increasing but earnings growth is slow or flat or negative, it is not a very healthy market and P/E will increase above the mean value. You will see price correction if the earning growth faster than price growth do not come by. It is best to invest slightly less in markets during such scenarios compared to your ideal asset allocation
  2. If you see the prices has been flat to decreasing and you see the earning growth coming or staying intact then you should opt to increase your allocation to equities compared to your usual asset allocation
  3. In all other scenarios stay with your own asset allocation

Those who are looking for thumb rules, let me share the updated P/E chart to follow as thumb rule.

PE Range as of Oct 05, 2018

Read more on Mutual Funds & Investment Planning, Happy Investing!!

Investment Objectives & Advice

Retirement Planning Part 3: Adjusting for Lifestyle Inflation

One common question i received over last few weeks is “Why are you focusing on retirement planning?”. I started with counter question, what other goal you want to plan for? Answers ranged from buying a car, buying a house or going for foreign trip, Child education etc. This made my reply simple, Have you heard of Car Loan, Home Loan, Education loan, Personal Loan? But Have you heard of retirement loan? During our retirement years, we are having limited future earning potential, Physical energy and fitness. Also, We should aim to have a peace of mind. Do you agree? If yes, Let’s continue.

In part 1 (Know your retirement corpus), we discussed about how to calculate your required retirement corpus. In Part 2 (Build your Retirement Portfolio), we talked about the type of funds to invest, based on corpus required and time horizons. Today onward we will talk about various risk in retirement planning and how to mitigate them. Due to increasing awareness, people have understood inflation but do you know two types of inflation?

Price & Lifestyle Inflation:

Inflation or Price inflation refers to rising price of products. 5 years back, If you were buying milk for Rs 30-35 per liter, probably today you will be paying Ra 40-45 per liter. In other words, If you were able to manage the household expenses in Rs 10k a month, today you will need Rs 12-15k a month. This is due to increasing prices of Fuel, Rentals, Grocery, Vegetables etc. As RBI now targets to manage this inflation, we can safely assume that it will stay in range of 5-7% over the next 5-10-20 years and hence can be planned for. This is uniform for all of us and we already adjusted for this, In part 1 (Know your retirement corpus).

Lifestyle inflation is more personal in nature and varies drastically. This is very high in the starting period of your career as you go through a lot of changes in your lifestyle. E.g. 10 years back, I depended on tiffin services for my food at Rs 20 per meal in turn Rs 1,200 to 1,500  month. with 5-7% price inflation this should have doubled to Rs 2,500 to 3000 a month. Though in reality, Now I try to eat from a better place, also order food from outside more frequently and occasional fine dine outings have moved my food bill to Rs 12k to 15k a month, which is growing by 8-10 times in 10 years. This is because of Lifestyle inflation.

Similarly, Now i will prefer travelling by flights or A/C coaches vs Sleeper or general class in trains. Prefer to stay in gated society in 2-3 BHK flat vs Individually rented rooms/sharing accommodations. Prefer to take a cab vs local buses, prefer to go to multiplexes vs watching a downloaded movie etc. These are all examples of Lifestyle inflation and should be there as your capacity to earn and earning rise over the years.

How to plan/ adjust for Lifestyle inflation?

We should definitely not devoid ourselves from the pleasure of buying the desired watch or go for the long due foreign trips but still make sure that it should not derail our retirement plan. There are two ways to keep the risk form lifestyle inflation in check.

  1. As the earning power increases, with your income, your expenses and savings should increase in similar proportions. Means, if your salary increases by 10-20% a year so should your investments. This will keep our expense ratio to income constant which should decrease after 10-20 years of working life as the growth of expenses should slow down.
  2. As the expenses are growing by not only by price inflation, Every year you should review your retirement portfolio requirement and investments need based on latest expense.

Read more on Mutual fundsRetirement Planning. Happy Investing!!