Importance of Defense

Offense is what we like, Defense is what saves us and in between the two lies the gulf of survival and failure. If you are a Cricket fan, you would have at the very least kept score of what is happening at the IPL. At the start of the tournament, one of the strongest contenders have been Royal Challengers, Bangalore given their incredible batting line up. Yet, year after year, they have failed to convert that into winning that coveted trophy. This year too, they are in a spot with them having to beat the opposition in every match from now on to remain in contention for the qualifiers.

So, what is Cricket doing in a finance blog you may wonder. Well, the reason RCB has failed to notch up the victories this time around for instance has not been due to lack of application in the offense (Batting) department. Its due to fact that their defense has been so weak that even big scores have been chased (hopefully today’s record setting score is something that is bit tougher to chase).

As a investor, we all love for our investments to grow strongly, but in bad times, do we have enough defense to enable us to meet our objectives? Equities is the preferred choice for those wanting to beat inflation by a margin but is that the right choice for one and all??

Lets go back a few years and look at the path that may have been traveled by a US Resident. After the crash of 2000, economy started to bounce back strongly though for a large percentage of population, the gains that accrued through their real estate investments was much more higher. So, a typical guy not only had a good / great paying job, but his investments both in Equities and Real Estate were providing him a nice return on his capital. Towards the end of 2007, he would have seen that housing rates were on the downturn but given the strong markets and the fact that he had a good job would mean that he hopefully can wait it out.

A year later, the perfect storm had hit mainland US and though he himself had not done any hara-kiri and despite not having done any major wrongs, he found himself with a portfolio that was down 50%, a house whose value was less than what he owed to the bank and worse, he had no job since the decline in markets affected the company he worked which in-turn laid him off.

We Indian’s have been lucky not to have experienced such a episode in recent years, but as we become more and more integrated globally, we can easily get hit by the Butterfly effect. Or you can also have a string of bad luck that leaves you gasping for breadth. Its at those times that the real value of your investments gain prominence.

When you invest in markets, your gains are all relative in nature. As long as the markets are good, the probability is that your returns will be good too which reminds me of the following quote

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” – Anonymous

As a investor / trader you should ideally aim for absolute returns but I am not sure how many even understand the difference between Relative returns and Absolute returns. While Mutual fund advisors laugh about those  investing in Fixed Deposits, do note that a FD is a absolute return instrument and one that is highly liquid.

In times of distress, Cash is King.  Real Estate tends to be pretty ill-liquid not to mention dependent on market forces (unless you are willing to sell at a discount) while Equity can get blasted with you value of portfolio down to a number which you wouldn’t have dreamed off when you first started investing.

If you are not a trader with ability to take advantage of both the bull side as well as the bear side, your next best bet will be to have a portion of assets in debt which can come to your aid when you need it the most.

As Warren Buffet says

I have pledged — to you, the rating agencies and myself – to always run Berkshire with more ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits. 

Tough times don’t last, but it pays to be prepared well in advance for all and any eventuality. Maintaining a good asset allocation mix is the first step in that direction.