The Lilly pond riddle
Let me start this month’s letter with a thought experiment. Let’s say that an investor is evaluating two equity-oriented schemes viz A & B.
The article is authored by Ajit Menon, CEO, PGIM India Mutual Fund.
Jan 2022
5 mins read
Share:
If any of your loved ones writes your name for the above question while filling out a form, then you have a
responsibility that you must fulfil. This month’s letter is on the behaviour biases that exist while dealing
with emergencies and how we can overcome them and be as prepared as we possibly can.
Emergencies are a fact of life. However, the most common reaction when we see someone else in an emergency
situation is to reassure ourselves that “this can’t happen to me” and walk away. Many emergencies also end up
being a financial crunch for someone who has not planned for it. In India, people are now insured to a greater
extent on life and on medical insurance too though penetration levels are still low compared to other markets.
However, in general, they are not really prepared for non-medical emergencies (layoffs for instance).
While there is enough literature on how to actually build an emergency corpus, as well as financial advisors who
can help create customized plan, the impact that it has on other areas is not fully understood. The benefit of
an emergency fund is not for its end use only (which I pray never occurs in your life) but for the many
intangible benefits. The first and obvious benefit is the confidence and self-respect that you gain, knowing
that you have taken the right steps to protect your loved ones, and thus lead a less stress-free life.
The second and third order benefit is that this prevents you from overspending on a whim, as your disposable
cash is stashed away and it saves you from getting trapped into borrowings (which invariably comes at a high
cost during emergencies). Additionally, the non-intuitive benefit according to me, is that an emergency corpus,
invested in safer assets, lets an investor stay invested in equity markets during volatile times, as he is not
worried about his basic requirements. Let me explain this further with the help of an illustration below:
Consider two investors A and B who are invested in the equity market and have monthly expenses of Rs. 50,000.
Investor A also has an emergency corpus worth 12 months of expenses, which she can draw down during tough times.
On the other hand, investor B doesn’t have such a corpus and is fully invested in equities. An emergency event
such as a layoff can happen at any time but may happen to more people during an economic shock and is likely to
be accompanied by a fall in markets. This may impact the financial outcomes for investors. Let us see this with
the example of a real-life scenario in 2020, the first year of the covid pandemic.
Consider that A starts with investments of Rs. 10 lakh and an emergency corpus of Rs. 6 lakh, while B invests
Rs. 16 lakh entirely in the equity markets. If both A and B lose their jobs in March 2020, A can draw down her
emergency corpus for a year and leave her equity investments untouched. On the other hand, B may have to redeem
Rs. 6 lakh worth of her investments to meet her monthly expenses for the same period. Worse, she may develop
financial anxiety and sell her investments at an inappropriate time. If B would have redeemed her investments in
panic on (yes, we are exaggerating to make a point), March 23, 2020, her financial outcomes would be starkly
different than A over the following year (see table below). Having an emergency corpus would make investor A
better off by nearly Rs. 4.5 lakh in a short span of a year. The bigger benefit being that A will have far less
financial anxiety than B and that’s worth a lot more than just the 4.5 lakh
difference.
Source: Nifty 50 data from MFI Explorer. The above table is for illustration purposes only. Emergency corpus of
Rs 6 lakhs goes to zero by April 21 since the expenses of Rs 50,000 is withdrawn every month for a year’s time
period.)
In conclusion, when you make your child or spouse or dependent parent etc. to save your mobile number in their
emergency contact list, it is your responsibility to also first set up a Plan to deal with any financial
emergencies. The easiest solution is to have an emergency corpus tucked away. As a thumb rule you can put away
six months of your monthly expenses or to be more conservative, a year’s expenses in a safe and liquid
investment. Since every individual and, by extension, household is unique, a good financial advisor can help you
with what’s best for you.
The article is authored by Ajit Menon, CEO, PGIM India Mutual Fund.
Share:
PGIM India Asset Management Private Limited
(CIN - U74900MH2008FTC187029)
Toll Free Number: 1800 266 7446
Email: care@pgimindia.co.in
This is an Investor Education and Awareness Initiative by PGIM India Mutual Fund.
All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
The information contained herein is provided by PGIM India Asset Management Private Limited (the AMC)
on the basis of publicly available information, internally developed data and other third-party
sources believed to be reliable. However, the AMC cannot guarantee the accuracy of such information,
assure its completeness, or warrant such information will not be changed. The information contained
herein is current as of the date of issuance* (or such earlier date as referenced herein) and is
subject to change without notice. The AMC has no obligation to update any or all of such
information; nor does the AMC make any express or implied warranties or representations
as to its completeness or accuracy. There can be no assurance that any forecast made
herein will be actually realized. These materials do not take into account individual
investor's objectives, needs or circumstances or the suitability of any securities,
financial instruments or investment strategies described herein for particular investor. Hence,
each investor is advised to consult his or her own professional investment / tax advisor / consultant for advice in this regard.
The information contained herein is provided on the basis of and subject to the explanations, caveats and warnings set out elsewhere herein.
The views of the Fund Manager should not be construed as an advice and investors must make their own investment decisions regarding investment/ disinvestment in securities market and/or suitability of
the fund based on their specific investment objectives and financial positions and using such independent advisors as they believe necessary.
