Factors That Can Make Or Break Your Portfolio

Bear in mind some key factors with regard to your long-term investment plan while picking mutual funds to build a strong portfolio, says Hemant Rustagi.

KEY POINTS:

• The level of success from mutual fund investments would depend upon the ability to focus on factors that are crucial in ensuring the right portfolio mix as well as to avoid those that can adversely affect the portfolio in the long run.
• Identifying the right level of risk tolerance and deciding a suitable asset allocation are key to the investment process.
• While making regular investments is the perfect way to benefit from equity or equity related investments, a haphazard approach to realign the portfolio amidst short-term volatility is most likely to backfire.

Mutual funds allow investors to allocate investments across different fund categories to achieve a variety of risk/reward objectives, thereby reducing overall portfolio risk. However, the level of success that an investor may achieve from his/her mutual fund investments would depend upon the ability to focus on factors that are crucial in ensuring the right portfolio mix as well as to avoid those that can adversely affect the portfolio in the long run.

Outlined here are a few of these factors and how they impact your investments:

Risk Tolerance

It is important for every investor to understand the right meaning of risk. For a mutual fund investor, risk refers to the fluctuations in the NAVs and can range from stable to very volatile. This is why identifying the right level of risk tolerance and deciding a suitable asset allocation remain the most crucial factors in the investment process.

In other words, the asset allocation in one’s portfolio should reflect one’s risk profile. Asset allocation not only reflects the kind of risk one is taking, but also the kind of returns one can expect. For example, if one decides to invest in equity funds, one must have the risk appetite as well as the time horizon required for such an investment.

Besides, fund managers have different philosophies and styles. To curtail risk in the portfolio, one must include funds following different investment philosophies as well as strategies. If investors are not sure about the right way to do this, they must seek professional help for the same.

Over-Diversification

It is quite common to see portfolios that have a large number of funds. Over-diversification is generally the result of following a haphazard approach. As a result, one may end up building a portfolio consisting of funds with good as well as poor performance. Needless to say, the presence of non-performing funds pulls down the performance of the overall portfolio.

Investors faced with such a situation must first take stock of the portfolio mix and then take steps to weed out the non-performing funds. Besides, it would pay to realign the portfolio to ensure that funds investing in aggressive segments such as Mid-Cap and Small-Cap do not have a very high exposure in the portfolio.

While redesigning the portfolio, the focus should be on funds that have been performing consistently and have good quality portfolios.

Short-Term Market Trends

While it is natural for investors to get affected by the short-term performance of the stock market, it is vital that they don’t allow it to influence their long-term investment strategy. In a falling market, for example, investors may either be tempted to invest aggressively or abandon an asset class like equity completely. Both these actions can be detrimental to the long-term prospects of a portfolio. While making regular investments is the perfect way to benefit from equity or equity related investments, a haphazard approach to realign the portfolio amidst short-term volatility is most likely to backfire.

When investors make an attempt to speed up the process of recovering losses in the portfolio by investing short-term surplus money, the results may often fail to match their expectations. The main reason for that is the unpredictable nature of markets over the short term. Over the long-term, however, these short-term fluctuations tend to smooth out.

Besides, investors often get disillusioned by the negative returns of equity funds. The fact remains that negative returns do not necessarily mean poor performance. Even the best of the fund managers are likely to deliver negative returns during period when the markets go down significantly. For example, short-term negative returns (in line with the market) from a fund that has been doing well for years means nothing. Similarly, even a bad fund manager can give decent returns when the markets are doing well. Besides, it is possible that a fund manager gives impressive returns by exposing investors to a higher risk than they can withstand.

One way to avoid extreme reactions is to rebalance your portfolio to maintain the asset allocation originally decided. No doubt, it can be tough to redeem in a rising market or to invest in a falling market, but rebalancing imposes discipline and ensures that the portfolio remains diversified at all times.

Hemant Rustagi
CEO, Wiseinvest Advisors