If you are a typical Indian, you are most likely to have gold in your investment portfolio. Most of you only differ in your choice of holding the yellow metal. Some hold it in physical form while others hold financial gold (gold ETFs). You apply what we call as hedged-consumption approach when you buy gold. In this article, we discuss whether you can apply a similar strategy to create a portfolio that can meet your lifecycle needs.
Safe haven
Most global investors consider gold a ‘safe haven’. That is, when there is a world crisis, such investors buy gold, because they believe that the yellow metal is the safest asset. Most Indians buy gold for a different reason. It is customary in our society to gift gold ornaments during festivals and weddings.
Now, you know that such occasions will arise in your family during your lifetime. So, what do you do? You either buy gold in small quantities over the years. Or you may choose to buy gold ETFs.
Suppose your son or daughter marries 10 years hence. At the time of marriage, you convert the physical gold or gold ETFs into ornaments based on family needs. In short, you buy gold as a hedge for your future consumption. We call this hedged-consumption strategy. This strategy largely explains why you buy gold even if the price moves up.
The question is: Can you use the same strategy to meet your lifecycle investments? This ranges from investing to buy a house to accumulating wealth to meet your post-retirement lifestyle and all other intermediate goals. It turns out that you cannot achieve your retirement goals or fund your child’s college tuition the same way you meet your family’s gold needs. But you can use the hedged-consumption approach to improve your chances of meeting your investment objectives. How?
Investment objectives
You could fail to achieve your investment objectives for two reasons. One, your equity investments may decline during your investment horizon. And two, even if your investment gives you the required return, you may be unable to reach your objective if inflation is higher than expected. A hedged-consumption approach can moderate inflation risk. How?
Take health care costs. Besides medical insurance and emergency funds, you have to invest in equity to cover your health care needs. This investment is important if you are a retiree, as it will help meet major illness that may occur as you age. Now, based on the hedged-consumption approach, you should buy stocks related to health care sector such as pharmaceutical companies, bio-tech firms and medical hospitals. The logic is simple: If health care inflation rises, revenue generated by health care firms should go up as well, and presumably, reflect in their stock prices.
You can use the same strategy to fund your child’s education plan. That is, you should invest in stocks of companies that are related to education sector such as e-learning companies and book publishers. What about buying a house? You should buy land today to enable you to make the down payment for buying a house sometime in the future. Why? Investing in land could be a good hedge against housing inflation. You can sell the land at a higher price and use the proceeds to reduce the increased cost of buying a house in the future.
Given the resources (time and money) required, you may find it difficult to directly buy stocks to create a hedged-consumption portfolio. It is, indeed, unfortunate that you do not have the choice of mutual fund products to help you create such a portfolio. Till asset management firms introduce more such products, you may have to do it yourself. But weigh the benefits of hedging your consumption needs with the costs of doing it.
(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. Feedback may be sent to >knowledge@thehindu.co.in )