Seemingly logical decisions may be completely wrong

People pride themselves on their rational decision-making, especially when it comes to their money. However, it has a way of leading us down wrong alleyways. These seemingly straightforward looking decisions may not be so straightforward after all. That is why many times people stub their toe on financial decisions.

Let us look at some of them to get a sense of what they could be.

To achieve goals, investments should give high returns – This looks as logical as it can get. Afterall, we do need high returns to have a high probability of achieving our goals, right? Not so fast!

When we talk of goals, they are very personal and specific. Add to that other unique factors that underlie a client’s situation like their station in life, personal preferences, temperament, risk profile, income needs, etc. In life, it is important to meet one’s cherished goals, in the time they come up. All that we do should align with what we want to achieve.

Hence, a portfolio is designed after considering all these factors. The portfolio components are put together in a particular proportion intentionally. Each portfolio component has some unique characteristics and they behave to a stimulus in different ways. That means something may do well at a certain point and some other portfolio component may not do well. But they have been put together in the portfolio to ensure goal achievement.

Disturbing such intentionally created portfolios only because some portion is not performing as well as other components, is a dubious logic that disrupts what the portfolio is expected to achieve for the family over time.

Investments should be such that they achieve a certain goal. Shooting for high returns disrupts the portfolio and takes it down an unintended trajectory.

Leveraged investments build wealth, especially in real estate – It is true that home loans are available at comparatively low interest rates. Hence, buying a home with borrowed money is a leverage that can build wealth.

There are many things to bear in mind, however. A home loan is sanctioned based on repayment capacity. Hence, based on one’s income, one will be able to get a certain loan, based on loan servicing capacity. Hence it is obvious that there is going to be a limit on how much one could borrow here – it cannot be unlimited.

Also, when big loans are taken that have long tenures, there are risks involved. Loan servicing over very long periods means that there needs to be a stable income stream over time. Such loan repayments can limit the flexibility and straitjacket one to stick to a certain level of income, even if the life situation demands a different response. For instance, if a couple has taken a home loan based on both their incomes, the lady may not be able to give up her job to raise the kids, as her income is needed to service the loan.

Leveraging and investing in homes also assumes that the returns one may get from real estate will be much higher than the interest cost. In some cases they are; in a lot many cases they are not, especially if we truly factor the full cost of buying a home. Most people do not consider the registration & stamp duty expense, brokerages, loan interest cost, cost of home improvements, etc. while calculating the cost of acquisition. If all these are considered, the returns may not be all that good.

Recoup losses in earlier investments from the current investments – This may sound like an ought-to-do thing, on the face of it. But making good past losses from the current investments would mean that one may have to invest in such a way that they offer very high returns. This would mean much higher levels of risk assumption.

This may not be desirable. Tying up past losses with the current investment may ensure that, even in the present, odds are stacked against the investor.

It may be a much better idea to accept the past losses and approach the future with a fresh perspective. Investments need to be made based on one’s personal circumstances, risk tolerance levels, goals and when they are coming up, tax efficiency, return expectations, tenure, etc.

Past mistakes are difficult to undo and a focus on recouping past losses would make things worse. We should instead look to the future and start with what can be done from now on.

Affinity to certain investments – We have found that many people have a great affinity to certain asset classes. Sometimes, it is to the exclusion of everything else.

We have seen those who firmly believe that real estate ( for instance ) is the best way to grow wealth. With this belief they invest only in this asset class. They have residences and land parcels all over the country. Since the portfolio is very concentrated, their entire portfolio will be subjected to the risk of the asset cycle. The same is true for someone who is heavy on equity investments, or other assets. However, most people do not change their opinion even in the light of their own experiences that point to the contrary.

There is one another problem. While investing, some components do not do well. It makes sense to sell off and reinvest. But that does not happen. For instance, if an equity share X is lagging in a portfolio of many equity shares, the investor will be reluctant to divest X and reinvest in another equity, even if evidence indicates it is the right move. They want that Equity X to give them the returns they had expected!

These are just some of the decisions people make, thinking they are right, while they are dead wrong! There are many more that can be road blocks on the way to building wealth. We need to uncover and understand what they are, so that they don’t end up creating problems in their wealth creation journey.

Suresh Sadagopan is the MD & Principal Officer at Ladder7 Wealth Planners and is the author of the book If God was your Financial Planner