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ShareLast week's column discussed what investors should expect from the market, now that it has run up significantly over the last six months.
Amongst other factors, it was mentioned that even though the GDP growth rate is expected to decelerate to 6.5 per cent this year, even this rate makes India one of the fastest growing economies in the world. Indian banks are well capitalised, well regulated and most are already nationalised. Our savings rate of 35 per cent and a favourable demographic makes India as insulated as it can get against a global recession.
Therefore, investors will do well to stop listening to market analysts who tend to extrapolate the present-day situation and present this extrapolation as a future expectation. Putting it differently, one of the most effective ways to achieve success in your investments is to stick with the basics and shut out all the ambient noise. Markets will rise and fall based on national, international, political, geo-political, economic and financial events. The trick is not to get sucked into the micro and instead focus on the big picture.
And the starting point of this is by means of clearly defined asset allocation and risk appetite-based investing. The reason that I can go to bed peacefully and get a good night's rest without worrying about what the Sensex will do the next day is because I haven't invested a rupee more in the market than what my risk appetite allows me to. Consequently, even if the stock market were to shut down, my existence or that of my family's will not be threatened.
Basically, asset allocation refers to the process of consciously spreading your investments across various asset classes in order to insulate your portfolio from the poor performance of any one single class of securities. The objective is to balance risk by diversifying investments.
Actually, most investors don't really put all their eggs in one basket. In all probability, you would have invested some money in direct equity, some in mutual funds... there would be a PPF account or two within the family. Gold and bank deposits would probably round off your diversified portfolio. However, notice that I have referred to 'consciously spreading your investments'. Do you know exactly what proportion of your investments are contained in which assets and why? Though we all eventually park our money in diverse instruments, the resultant asset allocation is more of an accident than design. For example, we tend to succumb to current market sentiment and the flavours of the season. Some time back, it was equity. Then came the downturn and investors turned all their attention to FMPs first, and then bank fixed deposits. Now, once again, it is equity all the way.
Now, if a tailor-made asset allocation strategy were in place, it would have first indicated that rather than going overboard on fixed deposits, during the market downturn, you should actually be adding a little to your equity portfolio. Basically, sticking to your allocation pattern would discipline you to buy low. And then eventually, when the market picked up and the aggressively-promoted equity products made a comeback, it is your asset allocation that would prevent you from succumbing to the seduction.
Sticking to the allocation pattern would have you actually reducing the equity component in your portfolio. In effect, you would have booked profits and sold high. And as everyone knows but seldom practices, buying low and selling high is the only way to make money in the stock market.
Determine your goals
That being said, we come to another aspect of the planning process -- setting achievable goals. Without having carefully thought out financial goals, any asset allocation or investment plan will be meaningless. Note, however, that the goals have to be realistic and objective. For example, you may wish to start a small business after retirement, your daughter wonders if you could lend a little financial support for her education abroad, you also want something in hand for her marriage when the time comes and then there is this small row house that you always wanted to buy at your native place... yes, the wants are many and all may not be fulfiled.
However, the thing to do is to put it down on paper, in terms of cold numbers. This way, you have graduated from having a hazy idea about your requirement to having at least a ballpark figure.
Now, in the case of your post-retirement needs, you need not worry about short-term fluctuations in the stock market. A large part of your investment for this purpose should go into stocks and mutual funds. But if your daughter is four years from entering college or getting married, you may need to tilt your asset allocation to safer fixed-income investments.
Rebalancing
Last, but not the least, there is the rebalancing. As you must have figured out, asset allocation can never be a one time exercise. Therefore, it is important to conduct periodic portfolio reviews, since over time, the value of the various assets within your portfolio will change thereby affecting the weighting of each asset class.
So, in order to reset your portfolio back to its original state, you need to rebalance your portfolio. Therefore, you would need to sell portions of your assets that have increased significantly and channel those funds to purchase additional assets that have fallen in value or increased at a lesser rate.
To sum
Studies show that for optimising the total return on your portfolio, selection of specific stocks, bonds or deposits is actually secondary to the decision of how much to allocate between the high and low-risk investments. So here it is -- for any kind of investment success, have a goal-based allocation plan in place and invest for the long-term. And yes, please do ignore the experts!
The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com
