As investors cannot avoid geopolitical risks, they must keep their eyes and ears wide open on political matters, both national and international.
As the calendar year comes to an end, we start expressing our gratitude to various people who have helped us in the professional and the personal fronts. But, the most memorable lessons in life often come via the mistakes which we made. So, it is time to reflect on our own investment mistakes and avoid the same in the future.
Politics matters a lot
As an investor you may not be interested in politics, but the politics around you matters a lot. For instance, the recent China trade war have had bearish effect not only on the Chinese equities market but also across all emerging markets, including India. Investors should learn from all the confusion caused by political leaders. Apart from the geopolitical risk arising out of the US-China trade relationship, elections in Brazil also had an impact on the Indian equity market. Geopolitical risk is a risk which an investor cannot avoid, so keep your eyes and ears widely open on political matters, both national and international.
Rising interest rates in the US
Increasing interest rates in the US hit emerging markets much harder. If you do a back of the envelope calculation, two-year US T-bill yields are more than three times their average over the post-crisis period as the US government consistently hikes interest rates. Owing to this, many emerging economies including India is getting affected in a negative manner. For instance, if the Fed increases rates then India will also follow the suit which will hit the corporate as well as multiple sectors.
So, what is the way out?
Diversification: It is the term which you learnt a long time back from your grandmother. Whenever you travelled for long distances, the advice was to spread your cash in different places, apart from your wallet, such as in your bag, suitcase, etc. Why so? Even if you lose the cash in one place, you can manage to reach your destination with whatever is left in other places.
We adopted this strategy when we were young. Are we using the same in our portfolio diversification? Ask yourself whether your portfolio is diversified. Studies shows that among investors who invest in SIP in India, over 80% have their investments in one of the schemes and over 90% have investments in only one asset class. Consider diversification seriously, no matter what the current market conditions are. Diversify your investment into multiple asset classes and products.
Rebalance your portfolio: Rebalancing your portfolio has a lot of merit. For instance, when the market is soaring, even the very conservative investor also begins to love taking risks. This beats the very basic concept of asset allocation. Suppose you choose your portfolio as a combination of debt and equity with which you are comfortable. Your allocation is a function of the distance of your goals from today.
The closer you are to your goal, the lower the percentage of equity in your portfolio. If you began with an asset allocation of 55:45 of equity and debt and rising markets cause this to move to 80:20, or even higher, it is time to go back to your original allocation by redeeming equity and buying more debt funds. Rebalancing as a strategy permits you to book profits and reallocate them.
To conclude, politics was a major source of stress in 2018 from Wall Street to Dalal Street. Gone are the days where fights are all about enhancing border walls and travel bans. Keeping in mind the about points, investors should appropriately diversity and rebalance their portfolio to reduce stress on their hard-earned money.
The writer is a professor of finance & accounting, IIM Tiruchirappalli