A portfolio that lets one sleep well is what an investor should aim for

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Things become difficult when unforeseen events keep on surfacing on a regular basis, making any prediction impossible.
By Amit Grover

While accepting the Noble prize for economics, Friedich Hayek made an astonishing admission: “Not only were economists unsure about their predictions, but their tendency to present their findings with the certainty of the language was misleading.”

Economics is not like physics where you have a definitive answer to a given problem. In economics, there can be many solutions to a given problem. Economics can have contradictory views, trying to resolve the same problem. For every PhD in economics, there is an equal and opposite PhD.

Economy and the world is a complex machinery and data is not stationary. Imagine over 175 countries with 7 billion people, millions of businesses, trillions of dollars of financial assets and a huge chunk of world GDP, and try putting this in an excel sheet to come to a conclusion.

If all this was not enough, things become difficult when unforeseen events keep on surfacing on a regular basis, making any prediction impossible.

In the last 5,000 years of banking history, the world has never seen negative interest rates. Today, more than 25% of the bonds in the world trade in negative interest rate zone.

While explaining interest rates, investing legend Warren Buffett once said that he never foresaw negative interest rates, nor does he quite know what they will end up meaning to the global economy and markets.

History shows that economists have failed to predict practically all recessions, which were recorded in financial history.

Most events that shaped the world were Black Swan events. We can only understand the world backwards, but it very difficult and almost impossible to predict things. It’s good to understand macroeconomics, but it’s also important to know its limitations. So being sure about something should never be part of the plan.

It ain’t what you know which gets you into trouble. It’s what you know for certain that ain’t true – Mark Twain.

Doubt is a good tool, when one is investing. This keeps an investor humble and helps to invest with right asset allocation. In the beginning of 2020, there was not a single research report that said economies the world over can slow down and markets can enter a bear phase due to a pandemic. Risk is what is left when you have thought about all things that can possibly take place.

Traditional financial textbooks teach one to look for efficiency, but in the real world of finance one should build a financial plan, which is effective. A plan where one can achieve his or her financial goals with the least amount of personal stress.

Harry Markowitz got the Nobel prize for designing an algorithm to design the most efficient portfolio. However, when it came to managing his personal money, he had 50% of his allocation in equity and 50% in fixed income. His explanation to his allocation was, “With this allocation, I can sleep well.”

Personal finance is more personal and less finance. The best allocation among asset classes is the one where an investor can comfortably say at all points of time that her view on markets is: “I don’t know and I don’t care.”

(The author is AVP for Learning & Development at DSP Investment Managers. Views are his own)