When money flow is tight, as is the case in the last few quarters, it is essential to know how to manage your wealth and portfolio. What is economic stress? It is basically a temporary economic decline, owing to which trade and industrial activities are reduced and, generally, people stop spending on discretionary items such as cars and homes. And business houses reduce capital expenditure, recruitment and expansion activities. Following are some measures one can take to reduce the long-term loss to your portfolio and wealth during economic stress.
Target consumer-based stocks: Irrespective of the prevailing scenario, people are going to buy basic necessities such as toothpaste, shaving cream, detergent and the like unless the scenario gets really really bad. So, it’s good have shares of companies that are manufacturing, distributing and selling these necessities.
Invest in companies known for high dividend yields: During economic stress, dividend shares often fall far less than non-dividend paying shares as the former become ‘yield supporters’. How does it work? Let’s suppose that you are holding two shares in your portfolio, namely ABC and XYZ.
ABC company’s share have a dividend history of R5 and whose current market price is R100. So, the dividend yield is 5% (5/100) whereas XYZ company’s share have no dividend policy with a current market price of R100. Let us assume that owing to economic stress, the price of both shares crashes to R60.
Now, the dividend yield of ABC’s share is 8.33% (5/60). Given an option to hold any of the shares, obviously you will sell XYZ. The same thing holds true for mutual fund and professional money managers. They too will sell shares of XYZ, which leads to more supply of XYZ in market than demand, leading to a further fall in XYZ share price. Also, when a company pays dividend during economic stress, it sends a positive signal to the market.
Park your money in fixed-income instruments: To avoid higher risk and wealth deterioration during economic stress, it is a good option to park your money in fixed-income instruments such as bank term deposits and government bonds to beat inflation and protect the capital. While investing in fixed-income instruments, avoid corporate bonds, especially high-yield bonds and mortgaged-backed bonds, as these have higher default rates.
Invest in tangible assets: During economic stress, one can consider investing in a tangible asset, which is likely to be unaffected by a drop in the purchasing power of the rupee. In the current market, investors that have good credit scoring, plenty of cash and less debt might be able to pick up properties at a distress price.
Avail opportunities: According to Jim Cramer, former US-based hedge fund manager, “there is always a bull market somewhere”.
No matter how bad the economy is, no matter how terrible the job market is, or how high the cost of debt is, there is always some pocket of the market where it is incredibly easy to make money because of circumstances that have converged. For instance, during economic stress, some companies may experience falling share prices while earnings-per-share hits the roof with a strong balance sheet without any logical reasoning. Investors should avail such opportunities offered by the markets.
Although a lot is made out of a country being in economic stress, it is not the end of the world. If investors conduct their affairs conservatively, do not depend entirely on their jobs and have cash in hand while boasting of little or no debt, they are going to be fine. Similarly, those who own business and focus on keeping costs low, have sufficiently high margins and reduce spending, are probably going to come out ahead of the game. Economic stress just means that the overall economy is shrinking; it does not mean that you can’t increase your income.
The writer is associate professor in accounting and finance at IIM Shillong