What we need is a simple strategy which doesn't force us to try and time the markets. And that's exactly what is offered by the simple time-tested techniques of asset allocation and rebalancing
19-Mar-2007 •Dhirendra Kumar
The gravest problem facing us today is whether India will make it to next stage of the World Cup but since none of us can personally do anything about that, let us, for the moment, talk about less important issues like investments. Over the last few weeks, the stock markets have seen a substantial drop. Whether we call it a crash or a correction, a drop of 15 per cent in such a short time is not the kind that we can help worrying about. Which is a pity, because that is exactly what an investor with a well-thought out portfolio would be able to do, even in a situation like this.
I can see two kinds of responses from individual investors to the drop in stock prices. There are those who believe (encouraged by what has happened at least twice earlier) that things will turn around pretty soon and the markets will again start their upward march. This sort investor is now feverishly trying to figure out which sector or companies will lead the charge this time. They are, basically, looking for a tip on what the next real estate will be. And then there is the other category, who have decided that the time to flirt with equity is gone and they should now sober up and settle down with fixed-income.
This sort are helped along with the cash crunch faced by banks which have resulted in a plague of advertising fixed deposits with numbers like 9.2 per cent and 9.5 per cent written all over them. At a time when stocks are looking shaky, a riskless 9.5 per cent in a year sounds wonderful. So people who would have thought 9.5 per cent over a couple months about par for the course some weeks ago have decided that discretion is the part of the valour and it would be better if their money survived to fight another day. Suddenly, investing in fixed income instruments like bank deposits and fixed income mutual funds is looking like the right thing to do.
Is it? Well, rushing into equity after it has risen and then rushing into debt after equity has fallen clearly isn't. Who is to say that as soon as you have locked in that seemingly attractive 9 per cent per year, the stock markets won't turn around and gain that much in just a months' time? And then as you've rushed around and unlocked the money and put it back into stocks, they'll fall again and you'll end up repeating the whole depressing cycle again?
Clearly, what we need is a simple strategy which doesn't force us to try and time the markets. And that's exactly what is offered by the simple time-tested techniques of asset allocation and rebalancing. The only way of actually solving this conundrum is to earmark a certain percentage of your total investment portfolio to debt, and no matter how fabulously the stock markets are doing, make sure that you maintain that percentage.
Periodically-say once a year-one should see if this percentage has drifted and shift money from the part that has risen to the other. This will automatically ensure that when the stock markets swing around, one has a good amount of profits already booked.
But that's something we should have done in the past and no doubt will do in the future. Most people are bothered about what they should do right now. And the answer is exactly what it would have been at any point, regardless of the current state of the stock markets. Keep only long-term money-that which you are sure of not needing for at least three years-in the stock markets and the rest in fixed income. And now, let's go back to worrying about cricket.