After crashing to 7,500 levels during March meltdown due to COVID-19, Nifty recovered to its previous high earlier this month and now is trading at its all-time high near 12,800 levels. Investors who did not panic and sell in March / April must now be sitting pretty and investors who used the March correction to tactically invest in equity would have made handsome profits.
There are two types of feelings when the market is at its all-time high. One feeling is of bullishness and expectation of getting good returns in the short to medium term. The other feeling is one of trepidation about an impending correction. If you tune into business channels or read expert views, you may get a sense of optimism and also hear concerns about valuations. You get similar mixed views about the economy. Investing should not be about hope or despair. You should always invest according to a plan and remain disciplined. In this article, we will discuss what you should do in this situation.
Asset allocation is important
Asset allocation is a strategy to balance risk and returns by investing in different asset classes. Diversification across asset classes can greatly reduce risk and generate potential superior returns in the long term. Financial planners suggest that right asset allocation is critical in achieving your financial goals. Extreme price movement of one asset classes relative to another can skew your asset allocation and overall risk profile of your portfolio.
The chart below shows how 50:50 asset allocations in equity and fixed income made 10 years back changed over time. In this example, we have assumed that equity allocation in Nifty 50 TRI and that the fixed income asset gave 7% annualized return.
You can see that at times, the equity allocation was well below 50% and at other times, fixed income was way below 50%. In this example, currently your equity allocation will be 55% (as on 13-11-2020) and your fixed income asset allocation will be 45%. In order to maintain your target asset allocation (50:50), you need to rebalance your asset allocation i.e. switch from equity to fixed income to maintain asset allocation at 50:50.
Source: Advisorkhoj Research (Period: 15-11-2010 to 13-11-2020). Disclaimer: Past performance may or may not be sustained in the future
Invest according to your financial goals
Do not let market levels dictate how you invest for your long term goals. While equity is volatile in the short term, historical data shows that equity gives good returns in the long term. The chart below shows the movement of Nifty since 1st January 2000. We had several bear markets over this 20+ year period. You can see that even if you invested at market peaks (as indicated by the blue lines), the market would have recovered, if you had a sufficiently long investment horizons. Some recoveries take less time (e.g. 2015-17, 2020), while others take longer time (e.g. 2000 – 04, 2008 – 14). You need to have a financial plan and invest according to it in a disciplined manner.
Source: Advisorkhoj Research (Period: 01-01-2000 to 13-11-2020). Disclaimer: Past performance may or may not be sustained in the future
Systematic Investments for financial goals
We have stated a number of times in our post that SIP is the ideal way of investing for your long term goals and wealth. Market levels are irrelevant in SIP because of Rupee Cost Averaging. Some people misguidedly argue that SIPs are not suitable in bull markets because you buy at higher and higher prices. These people are missing the fundamental point regarding SIP, which is about disciplined investing and creating long term wealth through the power of compounding. It is as difficult to predict how long bull markets can last as it is to predict when bear market will bottom. Sometimes bull market can last for many years (see the portions of the chart above circled in red). Do not try to second guess the market. Simply stick to your investment plan.
Choose different asset sub-categories wisely
Midcap and small caps have the potential to deliver superior return in the long term. Midcaps and small caps outperform large caps in bull markets and underperform in bear markets. So early stages of bull market rally might be a good time to get some exposure to midcaps and small caps. Midcaps and small caps have underperformed in India over last 2 years or so. They are now on their path to recovery. If you switched from small / midcaps to large caps over the past couple of years, now is the time to revisit your asset allocation and tactically allocate a portion of your equity portfolio to these segments. However, you should ensure that you do not overextend yourself in riskier categories because it can come to haunt you when markets turn volatile. You should always invest according to your risk appetite.
Diversification is important – invest in mutual funds
Bull markets are times when you get hot tips about stocks which are about to give multi-bagger returns. In most cases these are just market grapevine or rumours which you should not fall prey to. Diversification is very important in investing and more so, when the economy is looking to recover from a crippling recession. Diversification will not only reduce risk but can give superior risk adjusted returns because beaten down sectors and stocks will benefit the most from economic recovery. Mutual funds are the best investments from a diversification perspective. They invest in a diversified portfolio of stocks across different industry sectors and are managed by professional fund managers, who are much better informed about the prospects of different stocks than average retail investors and their information sources.
Weed out losers from your portfolio
Many investors do not want to redeem their funds at a loss, even if they are performing poorly over a sufficiently long investment horizon. It is just human psychology – we do not want to lose money. Getting rid of poor performers in bear markets is even more difficult from a psychological standpoint because the losses are higher. A bull market will drag even the poor performers upward, albeit less than the good performers. This a good time to take another look at your mutual fund portfolio and see which funds have not performed well over a sufficiently long investment horizon because your losses will be lower now. Do not hesitate to weed out poor performers, even if you are losing money. Switch over the funds that have a good long term performance track record.
Conclusion
One of the most important attributes of successful investors is that they are prepared for both good and bad times. The decisions made in bull market will stand you in good stead in bear market and vice versa. Stick to the fundamentals of financial planning. Invest according to your goals and risk appetite, focus on asset allocation, diversify and above all remain disciplined in your investment plan.