Though the stock market had a great run for the last few years, this year the market has turned volatile.
The Nifty 50 index has fallen around 10% in the last two months and more cuts in the near term are possible. The midcap and the small-cap segment of the market saw the most brutal cuts. The Nifty Midcap 100 index has fallen around 24% this year, while the Nifty Small Cap 100 index has fallen more than 35%.
It is natural for investors who have invested in equity mutual funds in the last year or so, particularly those who have invested in midcap / small-cap funds, to feel worried about their investments. It tends to make investors nervous about their exposure to one asset class, especially equity. To get your asset allocation formula right at all times, investors need to understand their risk appetite and choose the right strategy to build wealth in the long term.
“Diversification helps in balancing out the risks and returns to achieve adequate returns at the same time minimizing the risk for increasing the probability to get the return an investor is looking for,” says Chirag Mehta, Senior Fund Manager.
Volatility can be bothersome for one who does not have long investment tenors
The only way to deal with it is having an asset allocation that too with a little longer periodicity because as previously mentioned, it’s difficult to make sense of the volatility on a daily or weekly basis. The purpose of an asset allocation is to decide the allocations to equity and debt to understand your comfort level.
The superior outperformance of equity in the long term notwithstanding, volatility is stressful for investors, particularly for those, who do not have much experience in investing or those who do not have high-risk appetites. Volatility can also be troublesome for investors who do not have very long investment tenors. In our view, investors should have a minimum investment horizon of 5 years for investing in equity mutual funds. If your investment tenor is shorter or if you are nearing a financial goal time-line then volatility or a big crash may cause a substantial reduction in your investment value, from which you may not have sufficient time to recover.
1. Don’t Abandon Your Existing Plan
A sudden drop in the market can have dramatically different implications for someone just starting their career compared to someone nearing retirement. What’s important is you understand your situation and your financial plan. Your list of goals may include: saving for retirement, buying a house, starting a business, paying education costs for your children, or charitable giving. But for each goal added to your list, you’ll need to precisely define its costs, time frame, and priority. You’ll encounter several trade-offs as you start to prioritize and layout a timeline for your goals. Getting these details down on paper will allow you to create a solid financial plan. And that can help you get to where you want to go.
2. Evaluate your Comfort Zone in Taking on Risks
All investments involve some degree of risk. If you intend to purchase securities – such as stocks, bonds, or mutual funds – you must understand before you invest that you could lose some or all of your money. Unlike deposits at FDIC-insured banks and NCUA-insured credit unions, the money you invest in securities typically is not federally insured. You could lose your principal, which is the amount you’ve invested.
The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long-time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. The principal concern for individuals investing in cash equivalents is inflation risk, which is the risk that inflation will outpace and erode returns over time.
3. Stay Diversified
Diversification is a staple of investing. But as markets change, your portfolio may need to evolve. Times of volatility offers a great opportunity to reevaluate and possibly rebalance your asset mix. Fixed-income investments, such as bonds, generally can provide the potential for steadier returns than stocks. Asset allocation can help you reduce risk. Portfolio diversification may reduce the amount of volatility you experience by simultaneously spreading market risk across many different asset classes.
Improve your opportunity to earn more consistent returns over time. By investing in several asset classes, you may improve your chances of participating in market gains and lessen the impact of poor‐performing asset categories on your overall portfolio returns. Stay focused on your goals. A well-allocated portfolio alleviates the need to constantly adjust investment positions to chase market trends, and can help reduce the urge to buy or sell in response to the market’s short-term ups and downs.
4. Take an Active Approach to Risk Management
Don’t be passive in the face of volatile markets. After all, this is your money and your future. Being comfortable with your plan and your portfolio is important, but so is knowing your risk tolerance. Rather than attempting to time the market, focus on time in the market. While past performance is not a guarantee of future results, investors with diversified portfolios who stay in the market have historically and consistently experienced steady gains over time.
“The hardest part about choosing when to be in or out of the market, and we see this in the data all the time, is that missing a few key days or weeks of a five- or ten-year cycle can have a significant influence on an investor’s return,” says Haworth. “The pattern of returns is simply not predictable from month to month, so keeping a consistent investment can add to the bottom line.”
5. Consider Rebalancing Your Portfolio Occasionally
Rebalancing is bringing your portfolio back to your original asset allocation mix. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.
You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing. Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you’ve identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
To Conclude
To reiterate, there is no formula. But I would say that usually during retirement, the asset allocation can be about 50:50 into equity and debt or at least 35 should be in equity. However, in your accumulation phase, I feel it should be 75:25. So, there are different ways of looking at it.
Find your comfort and there is no formula that any expert can provide you.
