Investors should not react too much to price movements when the markets are volatile as it will harm their portfolios in the long-run.
While the benchmark indices are touching new heights, the broad market is performing poorly and many mutual fund schemes are reporting returns lower than their benchmarks. The mutual funds industry witnessed total net outflow of `32,628 crore in July 2018 as against net inflow of `45,475 crore in June this year.
While volatility in the broader equity markets due to intensifying global trade war concerns has led to the downside, individual investors investing in mutual funds are concerned because of the poor performance of most funds in the last six months, especially after getting good returns in 2016 and 2017. However, experts say the equities market in the short-run tends to be volatile, but long-term return potential remains high.
Volatility is a friend
Equity markets have displayed extreme euphoria and also extreme pessimism many a times in the past. Brijesh Damodaran, partner, BellWether Advisors LLP says most of the time investors prefer secular income with minimum volatility. “Which is why investors have a substantial allocation of funds in fixed income products irrespective of the liquidity needs and time horizon,” he says, adding that volatility is part and parcel of investing journey.
Every investor needs to know the purpose of investing and have a time-frame for his goal. Allocate funds in equity if the requirement of funds is after more than five years. For short-term liquidity needs stick to debt funds or fixed deposits. Do not let recency bias influence your decision to invest in direct stocks or any equity-related instruments. An investor must maintain caution towards anchoring to the past, especially when the prospects of the then invested securities looked bright.
In equities, one can start even with a small investment of Rs 1,000 every month. One must always do due diligence before investing and trust the investment as well as the investment process, and review the portfolio every six months. Never time the market and invest as per your investment plan and if you are not comfortable with the volatility or a paper loss of over 20%, then revisit the overall investment framework. Analysts say if volatility is affecting an investor, then he should look at large-cap mutual funds.
Volatility and asset allocation
Asset allocation involves constructing a portfolio that will minimise the investor’s risks during volatile times and meet the needs specified in the policy statement. Young investors should look at equity investment more aggressively and gradually reduce the equity exposure at a later stage in life. The thumb rule for equity mix is 100 minus your age. Also, investor should look at both single-period and multi-period perspectives in the return and risk characteristics of asset allocations.
As a part of the asset allocation and review process, re-balance the portfolio regularly. For instance, if the initial portfolio has 70% in stocks and 30% in bonds and the value of the stock holdings grows by 40% and value of the bond holdings grows by 10%, then the new portfolio mix will be 75% in stocks and 25% in bonds. To bring the portfolio back to the initial mix, the investor will have to rebalance the portfolio. However, take into account factors such as transaction costs and taxes. A disciplined re-balancing will not only help gain higher returns in the long run but also help attain the investment objectives.
Investors should not react too much to price movements when the markets are volatile as it will harm their portfolios in the long run. “The sooner you remove emotions and incorporate process in the investment framework, the more stable will be your return in the long-term.
Once the investment policy statement framework is understood, you should look into asset allocation and capital allocation,” says Damodaran.