How to navigate the hot market

Are the markets poised for a correction?

First and foremost, we have been expecting a correction for the last four years. Even at the peak of Covid, the market went down, and after that, it rebounded in just a month's time, and the ascent hasn't stopped since then.

The stock market's level is basically an aggregate of the underlying companies and their ability to generate returns. While pockets of the market might look expensive, I don't see anything alarming as of now. After all, SIP inflows are still rising. Besides the SIP money, the PF (Provident Fund) money and NPS (National Pension Scheme) money are rising.

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NPS money comes every month, primarily from private sector employees, and it is invested in the top 200 companies. Unless we face some calamity, where a lot of people get scared and impair the earnings capability of Indian companies, a sharp decline would be a surprise.

That is something we can't anticipate. Besides that, on the international front, the interest rates in the US have come down. If interest rates come down, foreign investors who pulled out might start investing again.

India remains strong. All the positive aspects of India's growth story are still at the forefront. We are beginning to emerge as a manufacturing hub. Parts of the market may look expensive, but there's a possibility that in one or two quarters, if the market remains steady and earnings rise, valuations will become cheap again.

Just because the market has risen doesn't necessarily mean it will come down. Investors need to adjust their mindset. That said, it could still be disappointing for many investors if there is a temporary drop, especially for those who have entered the market in the last two or three years. They haven't seen a declining phase yet, which takes a little getting used to.

The first level of preparedness, whether you're a new or seasoned investor, is to invest only your long-term money. If you invest short-term money, even a good investment can cause anxiety. Imagine if the money you need in eight months falls by 20 per cent, wouldn't that be unsettling?

So, make sure it's money you won't need for at least two to three years, even if you've been investing for many years.

Secondly, avoid taking a big exposure all at once. Even if you have Rs 10 lakh to invest, make sure you're spreading it over four to six months. This allows you to tide over market fluctuations. Otherwise, if you invest the sum all at once and the market drops, you may panic and exit at a loss.

Third, at Value Research, we advise on maintaining an asset allocation. Do your asset allocation when you have something meaningful at stake. In a market like this, a balanced view would mean having at least 20 per cent in fixed income. If you're a conservative investor, a prudent idea is to have 50 per cent in fixed income. Even for long-term investors with a sizable accumulation, one-third of your portfolio should be in fixed income. If the market drops, you'll be able to capitalise on it. If the market keeps going up, you'll still benefit, though perhaps at a relatively modest rate. However, the debt allocation will provide a cushion for your money and a mental anchor for you.

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This advice is particularly important for the large number of new investors who have entered the market in the last five years. For them, it's like buying insurance. Yes, you'll give up some returns, but it's worth it.

How can mutual fund investors avoid chasing short-term performance and instead focus on long-term fundamentals?

You don't have much control over which companies the fund manager invests in, but there are ways to avoid pitfalls. One is to avoid those funds that seem attractive just because they've done well recently. Many investors fall into the trap of chasing sectoral or thematic funds that perform well for a brief time but then fall from grace soon after. Avoid being lured by this.

Diversification is key here. Invest in a fund that spans across market segments - not just large-cap, mid-cap, or small-cap - but an all-cap fund. Additionally, diversify by investment style. Some funds focus on growth stocks, while others invest in value stocks. Most small-cap funds lean toward aggressive growth stocks, as it's hard to find value picks in that space.

Mix it up to take a holistic approach. If you have a couple of growth funds, ensure 20 per cent or a third of your money is in value funds. Different segments of the market are cyclical. When your growth funds stop performing well, value funds may begin to pick up.

What are the red flags investors should be cautious about?

It's tough to anticipate red flags during a market frenzy, and when they do appear, some might dismiss them. Often, time resolves these so-called red flags, and they don't materialise into actual problems. If you're following these strategies - diversification, long-term orientation, and asset allocation - most red flags won't matter.

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Hypothetically, if a market correction occurs, how can investors make their portfolios resilient during that period?

The answer is diversification, along with a long-term orientation. Diversification alone won't protect you.

Viewer's question

My investments in equity mutual funds are more than one year old. Thus, qualify for long-term capital gains. I have approx 35 per cent appreciation in my investments. Keeping in view the high market valuations, is it advisable to book partial profits by way of shifting 50 per cent of my corpus to balanced equity funds? - Archit

If you have plans for that money and are investing toward a specific goal, then by all means, take your money out. But just because it has gone up isn't reason enough to sell. The only other reason you should consider when selling is if your fund is underperforming. This year, the average equity fund is up 28 per cent. Two years ago, it was up 25 per cent. But last year, the average equity fund gained 3 per cent. When you look at these returns, 3 per cent isn't so disappointing, especially if you captured the 25 per cent.

The issue with taking money out now is that half your money which has gained 35 per cent is subject to long-term capital gains tax, which is 12.5 per cent. Taking your money out will shrink your capital if you don't have a clear plan.

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Also read: Value, boom and bust

This article was originally published on October 04, 2024.