COVID-19 has taught us many financial lessons, with staying prepared for such events being the essential one. In our previous discussion, we talked about the importance of having a contingency plan to stay prepared for the next crisis. Now in this subsequent part, we will talk about the importance of being a disciplined investor.
Economies and markets go through their own cycles spanning over months, years and decades. To safeguard against these overbearing external factors, one should focus on maintaining discipline. It helps you bring an all-weather flavour to your portfolio and prepare for any eventuality.
Systematic investing has multiple benefits. Investing via the SIP route helps you accumulate a corpus over a period. Think of it like the reverse of an EMI. It helps you invest in a fund at predefined intervals with a predefined amount by putting your investments on autopilot.
This way you accumulate units of a fund at different prices or net asset values, thereby averaging your investment cost. So, the chances are that you will suffer less or at least panic less in case of a sudden fall. So, SIPs, by design, take anxiety out of the equation.
The data from AMFI suggests that the number of SIP accounts have increased from 3.14 crore in April last year to 3.63 crore as of February 2021, highlighting the rising awareness and adoption of SIPs.
You might have seen ropewalkers enacting the balancing act in circuses. They usually hold a pole to maintain their balance. In a similar way, asset allocation provides stability to your investment portfolio. It's all about having the right proportion of different asset classes like equity, gold, etc. The asset-allocation mix varies among individuals, depending upon one's time horizon and risk tolerance.
1. Know your investment horizon
- The shorter the horizon, the safer the investment vehicle should be. So, for one to three years period, one should restrict to investing only in debt instruments. Such products provide the much-needed stability, an essential requirement for goals to be met over shorter horizons.
- A combination of equity and debt instruments should be used for goals with horizons of, say, three to seven years. As your horizon increases, the more equity you can have in your portfolio (as per your risk tolerance). Equity helps to provide your portfolio with a kicker in returns, while debt provides the much-needed stability.
- For longer-term goals, one can majorly invest in equity. But as mentioned above, figure out your comfort with that. While the reactions to market crises can differ significantly among investors, a first-hand experience through a crash can give a clearer picture of your personal risk-taking abilities. Think about what you did with your investments when the markets fell in 2020 or even those prior to that. That would provide you with a peek into your temperament for equity. You should take stock of such experiences and make any necessary adjustments so as to be better prepared for the future.
2. Time the market the right way
You can time the market, but just not the way you want to. Confused? It's the concept of rebalancing that we are referring to. Rebalancing helps restore your desired asset allocation and make adjustments when market movements cause your target allocation to lose balance. So, you automatically end up buying equities at market lows and book profits at highs.
3. Don't overlook debt allocation
Most investors give attention only to their 'equity portfolios'. While debt markets may not seem as exciting as stock markets, having a debt allocation has its own significance. It is a tendency of aggressive investors to have an all-equity portfolio. During market crashes, such investors see a drop in their portfolio value as well as lose a great opportunity to buy more through rebalancing.
Another aspect is that there are individuals who invest in the PPF, EPF, FDs, etc., but are under the wrong impression of having 100 per cent equity allocation. Thus, while looking at your asset allocation, always take a holistic approach and consider your entire investment basket.
Importance of time
While the reasons for a market crash may vary, the crash itself follows the same trajectory every time - a period of sharp market fall followed by an eventual recovery and a march ahead. But nothing could have prepared anyone for what happened last year, nor does one know what might happen the next year. One has to understand that the unpredictability remains.
The COVID experience further reinforces the broader point regarding focusing on things that are under your control. Also, the critical success factor for an investor in any crisis is having sufficient time in hand. Thus, choose equity only for long-term goals.
When an earthquake strikes, the buildings made of inferior material are the most vulnerable. Similarly, investments of inferior quality usually get wiped off in a crisis. During ultra-low-interest-rate environments, people tend to trade their fixed deposits for high-yielding bonds. That's precisely what is 'adding vulnerability' to your portfolio. It is better to stay away from inferior-quality products. This quality argument extends to banks as well. The customers of PMC and YES Bank have learned this the hard way. Therefore, it is important to wisely choose with whom to have your banking relationship. Don't just base such decisions on the interest rate being offered.