What Is My Balance Sheet Not Telling Me?
We all know that the Balance Sheet or more clearly, the ‘Statement of Accounts’, provides a screenshot of your net worth in one quick glance. But like the good old professor reminds us in our first Accounting class, the most important item on that page is the one we often fail to give sufficient importance to and that is the date!
What your Balance Sheet is telling you is true for this date only. In fact, in today’s fast-changing environment, even the time stamp is important, for it only takes a moment for those numbers to rapidly improve or deteriorate.
What this means is that the investments that look good on paper right now – may really not look half as satisfactory a decade from today.
Guard yourself against these common biases and errors:
1. Excess Cash/Savings Bank Balances:
Idle money should be put to work as much as possible. Liquid and Debt Funds offer safety and liquidity comparable to a savings account, with better returns and possible tax savings to boot! The old habits of building a fat savings/cash balance are better replaced with an automated SIP or other similar buys.
2. Fixed Deposits:
An attractive, safe looking item that beefs up your Assets side, right? Consequently, something we tend to keep adding to, year after year. However, you could be replacing this with funds at comparable risk that earn you a far better inflation and tax-adjusted rate of return.
3. Tax Saving Instruments:
Indians love to save taxes. Taking home a greater net amount feels good and leaves us feeling like we have somehow beaten the system. Unfortunately, this may be far from the truth. After adjusting for inflation and the cost of missing out on more lucrative returns in low/modest risk investments, in most cases, we would end up far wealthier by paying off the taxes and investing the proceeds elsewhere. In the longer run, you will have higher liquidity and earn better returns.
4. Excessive Life Insurance:
Insurance is not synonymous with investment. After providing for an appropriate cover, any excess funds would fetch higher returns invested elsewhere.
5. Unmonitored Equity/Funds:
We can’t simply buy and forget about these big-ticket purchases! A common investor mistake is to go by hearsay/recent experiences and assume that a similar trend will continue. Continuing to buy more of a non-performing runner can eat quietly into your wealth goals. Reviewing and rebalancing your portfolio on a regular basis is a must!
6. Real Estate:
As reassuring and secure that owning a piece of real estate feels, one needs to watch out for the unsaid here. Your balance sheet is unlikely to reflect a realistic, current market value of the property. Also, anticipated increases in maintenance, taxes and other costs are something one must take into account while choosing to remain invested. Further, market trends, encroachment, environmental and other risks must also be monitored routinely. Keeping your anticipated requirements in mind, you may also need to plan for shifting to a more liquid instrument as you can realize funds from there instantaneously.
7. Loans Extended and Purchased Bills:
Keep an eye out on whether these remain sound and realizable. Over time, the risk profile and therefore advisability of these may change.
8. Over Valued Assets:
Some assets such as Vehicles, Race Horses, Art, Gemstones, electronics, etc… can look rich on paper. But in reality, their realizable value may be far less and difficult to transact. Think twice before considering these as genuine value additions!
9. Credit Card and Other Outstanding Loans:
Even small principal outstandings can cost interest that eats heavily into our wealth building efforts. The compounding effect of interest and tenure can be far more expensive than what it looks in this snapshot. Routinely evaluate, prioritize, and pay off your liabilities as per your changing liquidity position.
So we can see that the Balance Sheet cannot accurately present the time value of money and other tenure related factors in a clear, visible manner and some diligent, routine study is required to stay on the top of things.