From investing regularly to booking profits on time to balancing risks and avoiding over-diversification, investors need to have well-defined strategies to ensure higher long-term returns
The year 2021 is expected to be a year of rebuilding and hope after the world suffered unprecedented setbacks brought about by the global pandemic last year. Interestingly though, many investors registered good returns in 2020 on investments such as equities and gold despite the global economy getting battered by the Covid crisis. As the new year sets in, it’s time to take stock of how our investments have fared and build pragmatic strategies to earn higher returns in 2021. So, what can we do to ensure we reap rich dividends this year? Here are some tips.
Let’s say there are two friends—Rajesh and Rohit. Rajesh invested Rs 1 lakh lumpsum in shares in February 2020 when the Sensex was around the 48,000 level. At the same time, Rohit started investing Rs 10,000 every month in the selected stock’s portfolio. After ten months, i.e., in December 2020, the Sensex was again at around the 48,000 level after dipping to 26,000 on March 23, 2020. While Rohit managed to get a return of more than 25% on his investment, Rajesh got a return of only 7% during the same period.
This example underlines the importance of investing in instalments regardless of where the market is. Avoid a lumpsum investment as the Sensex is already at an all-time high. Regular investments can help you reduce the volatility risk and generate higher overall returns in the long term. If the market witnesses a substantial downward correction, you may increase the investment amount at that time.
Book profits timely
You should know the right time to book profits when your investment value rises and exit your investments when its value falls. The value of your stocks may not rise continuously forever. You may keep the profit margin in your mind when investing and book the profit as soon as your investment value increases to that level. Similarly, all your stocks may not perform well at the same time. So, you must also set the stop-losses for each scrip to avoid a big loss. If the future performance scenario of any of your stocks becomes negative, you should be ready to replace them with a better share.
Balance the risks
Taking higher risk than your capacity can increase your losses whereas taking lower risk than your appetite can reduce your investment returns. So, the idea is to balance your risks when you invest money. You should always be prepared to rebalance your investment portfolio to keep them in sync with the changes in the market situation. For example, when your allocation in equity assets exceeds the required exposure, you may switch the excess fund from equity to debt or other lower-risk asset classes. Similarly, when your exposure to low-risk investments increases, you may switch the excess fund to equity class. Portfolio rebalancing can help you in maintaining an appropriate level of risk to reward ratio.
Be careful when you invest in bonds
Bond prices are inversely correlated with interest rates. When the interest rate increases, bond prices fall and vice-versa. The prevailing interest rate is low, and it may start rising in the future. Reserve Bank of India may tighten liquidity and increase key policy rates gradually to keep inflation in control during the year. So, in 2021, you should be careful when you invest in bonds or debt funds that invest in bonds.
Diversification of investments across various products and asset classes with varying degrees of risk and rewards is essential to keep the overall investment risk under control and generate higher overall returns. However, investing in too many products, i.e. over-diversification can destroy your returns on investment. As such, diversification should be used as a tool to reduce the risk, not to eliminate the returns. The level of diversification should be aligned with your ROI expectation.
This is called optimal diversification. For high returns, you need to take a higher risk; if you suppress the risk through over-diversification, it may suppress the return level too. Plus, it’s harder to keep track of so many investments in an over-diversified portfolio.
The writer is CEO, BankBazaar.com