In the first nine months of the year, the Sensex has delivered an absolute return of over 25%; no other asset class even came closer. If we look at the same period last year, the 30-share benchmark gave negative returns, with all other asset classes outdoing it. However, since January last year, the Sensex has given a return of 36% and an annualised return of over 24%.
What do these numbers depict? Statistics are typically used to put across, or confirm, what is desired to be conveyed to the end user and, thereby, influence his choice or drive home an assertion. With rising equity prices, one hears all kinds of euphoric statements. So, what should be the near-, medium- and long-term investment approach in such a scenario?
Approach to equity investment
The perception of the Indian market among investors has changed domestically. The price of crude has started to trend down only in the recent few weeks. A ?recency bias? to the investment is a well-accepted fact in behavioral finance and it affects most retail investors.
In euphoric times, you throw caution to the wind and invest in equities in the short term, which could be between zero and three months. You could gain or lose depending on when you have invested. However, it is always prudent to look at the asset allocation strategy, which is crucial for all times.
For cash-flow requirements, for the medium term (1-5 years), the investment could be in a combination of MFs, (liquid and balanced funds) corporate fixed deposits with AAA+ rating and bank deposits. There is a need to understand the difference between risk and volatility. Risk is permanent loss of capital and volatility is the movement in prices on a daily, weekly, monthly basis.
Volatility does not erode your capital. It only depicts the movement and change in the portfolio value. What matters should be price you get when you execute the sale. It?s when you sell that there is a gain or a loss, rest all is paper profit/loss, which should not matter in the long-term wealth creation.
Another basic investment rule, overlooked by most, is to invest with a plan and a goal. The temptation for quick gains could lead to permanent loss, which is risk. What?s important in the equity investment process is the ability to wait and watch one?s investments grow. Remember, just a year ago, no one wanted to invest in equities, but that has changed. Today, it is one asset class that most investors want to put their money into.
First-time equity investors, in late 30s, should look at a combination of liquid and balanced funds. A year later, one must look at stocks for long-term returns. For a young investor in mid-20s, allocation to equity up to 80% of investible surplus can be considered.
As India is in a multi-period growth phase, it will be wrong to say that you have missed out on the stock rally. So, pursue the asset allocation methodology and have clear-cut short-, medium and long-term plans in place. Have your own benchmark for returns and, preferably, do not make comparisions with returns made by friends and peers. Each of you have your unique needs and carry out your investments based on your needs and goals.
The writer is managing partner of BellWether Advisors LLP