Ancient Chinese philosopher Lao Tzu once said that the one who has the knowledge does not predict. In personal finance, everything we do is about the future. Economists predict growth rates in the year ahead. Stock market analysts predict profits for the year ahead and carve out estimates for growth. Today’s prices are a function of tomorrow’s profits, goes a stock market philosophy.
The World Bank and the International Monetary Fund, the two premier global agencies, are currently amidst their annual spring meetings. Based on multiple data points related to inflation, trade, pandemic and geo-politics, their estimates for growth are trending down for most countries.
Unlike in the past, there is voluminous data to help you estimate the future trend. However, all of that did not succeed in predicting a crisis like the global financial crisis or the Covid-19 pandemic. The economic impact of the two events was catastrophic for many nations. As share prices tumbled and currencies crashed, individuals suffered financial losses.
Understanding market cycles
Financial markets go through cycles. That applies to economies or markets. If things are on an upswing today, they could go down tomorrow. Prices of goods and services also move in cycles based on demand and supply scenarios. You need to understand that interest rates matter to your finances more than anything else. A phase of low-interest rates is bound to be followed by a phase of high-interest rates. When interest rates are low, borrowing makes sense. However, when the interest rate cycle turns, you need to watch out for the expensive loans to finance your spending. Rising inflation is a good indicator that you need to hold back. You do not need to be an economist to figure out that the era of low-interest rates is over as the prices of goods and services you buy rise sharply.
When investing in the stock market, you may want to consider that share prices cannot simply continue to rise. While in the long run, they trend upwards, they always move in cycles. After successive days and weeks of a bull run, you may want to brace yourself for a stock market correction. If that bull run is too sharp, a similar fall is imminent. Share prices cannot move too much farther than the underlying companies’ profits. They tend to fall in line eventually.
How do you prepare
A disciplined approach to investing allows you to prepare against an eventuality. You cannot assume that you will not face personal shocks. You must meet your financial advisor and discuss your ideas. The time you spend with your advisor will determine the direction you give to your savings. You need to have adequate life insurance and health insurance. The Covid-19 pandemic has underscored the importance of an emergency fund. You must ensure that you put aside money regularly to take care of expenses if you stay out of work for months. It is safe to assume that there would be inflation. Prices of goods and services you buy today regularly would rise. Years later, you need adequate money to pay for expenses when you retire. You can save and invest periodically when young in small quantities for the future.
You may want to avoid paying too much attention to the ‘outperformance’ of fund managers or stocks. If you are not from the financial sector, you are better off not finding more about investments that could do better than others. Passive investing has benefitted individuals across the world. Households have created wealth by deploying savings regularly to index funds. There will always be temptations around. A hot property or a stock market tip is always available. If something is that common, then everyone can get rich quick. Knowledge is your only weapon against any uncertainty. However, if you feel overwhelmed with information, you may choose passive investing through index funds to secure your retirement or other long-term financial goals. It is not possible to predict the future. However, it is possible to prepare for any eventuality. All it needs is your commitment and discipline.
(The writer is editor-in-chief at www.moneyminute.in)