Perfect portfolio post-ECQ
Question: Stock prices are down and look incredibly attractive, but, so are bonds. What would you recommend as the best diversification strategy to take now and after the ECQ (enhanced community quarantine)? Asked at “Ask a Friend, Ask Efren” FREE service at www.personalfinance.ph, SMS, Viber, Twitter, LinkedIn, WhatsApp, Instagram and Facebook.
Answer: Grab the longest and most straight stick you can find. Place one end of the stick on your palm and try to balance the stick by looking at the end touching your palm. Was it difficult? Now, try to balance that stick by looking at the end that is far from you. Was it easier? The far end of the stick represents your goals and the near end your tools. Simply put, you cannot achieve your goal by focusing on the tools. Diversification is a mere tool to achieve your financial goals.
There is an added danger to focusing on tools and that it tends to give rise to greed. I am reminded of this quote from the world’s greatest trader, Jesse Livermore: “The pockets change, the suckers change, the stocks change, but Wall Street never changes because human nature never changes.” There is now talk of the new normal. Yes, things will change in a big way in the next few years. Social distancing for a social being will be a thing. But life will eventually revert to the “old” normal. Why? Because human nature never changes.
And when it comes to giving financial advice, the old normal is that a financial planner worth his salt will go through a comprehensive needs analysis before he gives recommendations that are specific, measurable, achievable, relevant and time-bound.
Simply put, the old school yet true financial planner will quantify each of your goals, compare them with the funds you have to start with, what you can add periodically, the time you have to invest and temper them with your risk preference. The end result will be a rate of return per goal that will ,in turn, help determine the investment outlets you should get into.In terms of execution, you need to remember that prosperity begins with “S” and that is saving. But it is not enough to just have a high savings rate (net income ÷ revenue = net income margin). Savings need to be put to work in earning assets to bring in more revenues to help you realize future goals easier and faster (revenues ÷ total assets = asset turnover).
At the same time, you can also use other people’s money or debt to achieve your goals provided that the returns you expect to make will be more than enough to offset the cost of the debt and the cash flow needed to repay such debt. And for as long as that debt will be used to buy earning assets and not just for mere consumption, your debts will have a multiplier effect to your equity (assets ÷ equity = equity multiplier).
Now this is amazing. If you multiply net income margin to asset turnover and to equity multiplier, you will arrive at net income over equity or return on equity. In other words, the more income you save, the more you put your savings to work in earning assets and the more you borrow to invest in earning assets, the higher will be your return on equity, your equity in your household finance.
More than just diversification, the perfect portfolio pre- and post-ECQ will always be the combination of your savings, investments and borrowings as defined by your goals and tempered by your risk preference. To complete that combination, secure the common denominator to savings, investments and borrowings, that of protecting your downside through insurance. COVID-19 was one rude awakening to the need for life and health insurance. INQ
Efren Ll. Cruz is a registered financial planner of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books in the Philippines. Join our free webinar titled “Is ‘mana’ really manna?” scheduled for May 15, 2020. For details, email [email protected]. To inquire, email [email protected] or text at 0917-9689774.
