Debt vs Equity

Many years ago, right before the subprime crisis, people were worried about a sudden drop in the stock market. Concerns about an impending crash were looming, which received two kinds of responses.

First, some believe that things will turn around pretty soon, and the markets will again start their upward march. This sort of investor feverishly tries to figure out which sector or companies will lead the charge at such a 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. During the time I made this observation, it was particularly alluring to choose fixed deposits. At a time when stocks were looking shaky, a riskless return on par or even more than inflation in a year sounded wonderful. Suddenly, investing in fixed-income instruments like bank deposits and fixed-income mutual funds looked like the right thing to do.

Once again, now with the ongoing crisis and volatility in the markets, the same question is on the discussion again. Of course, yes, a few more instruments and commodities are also a part of the conversation now, but broadly, the question remains the same. So has the answer changed for this despite the fact that it is around 18 years old? The answer is old enough to vote now. Not really.

Think of this. Rushing into equity after it has risen and then rushing into debt after equity has fallen clearly isn't helpful. Who is to say that as soon as you put money in a fixed deposit, stocks won't rise and give back that return and more? 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 during such times is a simple strategy that doesn't force us to 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 were bothered at the time about whether they should get started with asset allocation. 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. Even now, people rush to create an asset allocation at the last minute.