The stunning collapse of Lehman Brothers and the crisis engulfing Wall Street is having an impact across the world. There could be several more developments over the next few months that might make things more difficult.
For investors, this is an important period to learn from such developments. This will ensure that they are not in a tough situation in the future. Here are five such important lessons.
US crisis spooks global economy
Every investment has risk: Typically, during good times, investors tend to ignore the risk element in a paper and focus only on returns.
Investors in equities stand to lose their entire money, if the company goes down. The plunging shares prices of Lehman Brothers, Freddie Mac and Fannie Mae to one dollar proves that entire market capitalisations can simply get wiped out.
Even debt market products get badly hit on account of the write-down of the debt that they hold. So, a portfolio needs to be as diversified as possible to insulate a person for such situations.
Everything is interlinked: From the price of a stock to an insurance policy, everything is linked. A fall in the price of a particular stock in Europe could mean the overseas mutual fund, where you have invested, is likely to see a fall in its net asset value. Even an insurance policy with a domestic company, which has a foreign partner, can be adversely impacted.
The latter implies you will lose your premiums as well as your cover. While such risks cannot be avoided, a portfolio that contains only domestic stocks or an insurance company may sound safe, but there is no guarantee that it will not be impacted adversely.
Diversify, the only mantra for retirement planning: The result of all the financial planning is gauged by the final corpus that you are able to create for retirement.
A sufficiently-big nest will ensure that there are adequate funds during the sunset years. Many people, even those who are in the financial sector, make the basic mistake of putting all their eggs in one basket.
Many a time, employees buy shares of their own companies thinking that being an insider they are privy to the most-sensitive information. This could lead to a great risk, if suddenly something were to go wrong.
The solution again is diversification. Having exposure to local equities, international equities, debt, commodities together would be a better idea to create a sound portfolio that will weather tough times. And even within each of these areas, spread the money across investment options.
Treat your career like an investment: Most people do not pay the right amount of attention to their career or working life. Just like an investment that needs constant monitoring and analysis, there is a need to monitor the career in the same manner. Most people are shocked when they lose their jobs.
The better way is to be prepared for the worst. That will help to insulate you from any career related problem.
Also, concentration on issues like upgrading skills through training, attending conferences and seminars and networking will help to improve your career. Yes, all these cost money. However, the returns over the years are much more.
Save during good times: Most importantly, when the earnings are high, save well. Good times are not for ever. Creating a meaningful portfolio or a simple savings corpus would be of great help during bad times. Proper investments will ensure that there are reserves that can be used during emergencies.
A sum of Rs 10,000 saved each month for 25 years growing at 15 per cent annually will give rise to a corpus of Rs 2.55 crore (Rs 25.5 million). All this money can be rather useful when the cash flow actually stops.
The writer is a certified financial planner