Nurture Your Equity Investments

All of us expect to earn handsome returns from our equity portfolio. Although there is nothing wrong to expect that from an asset class that is potentially the best among all the financial assets, investors must know how to deal with the mystique that surrounds the stock market. It is important to know that equity investments require time commitment as well as the discipline of investing on a regular basis. It is equally important for investors to give due importance to their asset allocation as it not only determines the kind of risk one is taking on the portfolio but also the kind of returns one can expect from it.

Unfortunately, whenever the stock market presents an opportunity for investors to earn healthy returns, they react differently. While on the one hand, there are investors who show total disregard to their asset allocation in a bull market by allowing the portfolio to ride on, on the other hand, there are investors who hurriedly exit from equity completely and move into debt. Both these reactions expose them to different types of risk. Investors who do not rebalance their asset allocation i.e. to bring it closer to their original allocation expose themselves to much higher risk then what they can bear. Similarly, those who exit in a hurry miss out on gains to a varying degree. Therefore, re-balancing the portfolio, either up or down, is a necessary ingredient for the long term success.

Over the last few months, the stock market has turned from a declining one to a rising one. Normally, during an upward move in the stock market, especially after a prolonged volatile period, large cap stocks perform better than mid-cap as well as small cap stocks. In the current rally, mid and small cap stocks have out-performed their much fancied large cap counterparts. A situation like this can be quite tempting for investors to increase allocation to mid and small cap stocks. Considering that a move like this can make the portfolio risky, it would be sensible to keep a bias towards large cap stocks. Generally speaking, a long-term investor should have an exposure of 60 per cent to large cap stocks/funds and the balance in mid and small cap stocks/funds.

A rising market makes the decision making a little difficult for investors. For example, all those investors who have been waiting for the stock market to bottom out must be wondering whether they have already missed the bus. Then, there are investors who may have exited during the initial phase of the rally must now be regretting their decision. Besides, those who discontinued their SIP investments in equity funds, fearing the further declines, may already be contemplating to restart their investment process.

Therefore, the right way to invest in equities is to follow an asset allocation model based on one’s time horizon and risk profile. This needs to be followed irrespective of the fact whether one is investing in a rising market, falling market or in a volatile market. For example, investing in equity or equity funds for a time horizon of one year can be a risky proposition even when the markets are expected to perform well. Similarly, investing for the long term in equities invariably works in an investor’s favour provided he follows a disciplined approach of investing in them. The key to success is to invest in the right kind of stocks or equity funds and in the right proportion.

As is evident, a long term investor should not allow short term market movements to drive his investment strategy. In other words, if one invests in equities as a part of one’s retirement planning, tracking price movements on a daily basis makes no sense. The most important factors to ensure long-term success are to own a good quality portfolio, follow a disciplined approach and monitor the performance regularly.