How do you ride a manic depressive stock market?

Assuming a higher return than what the long-term average warrants based on short-term market movements may mean that you may fall short of the goal value that you are targeting (Photo: iStock)

Investors wealth rose by 10,000 crore over two trading days in the third week of September. Suddenly, the gloom that had settled over equity investors seems to have lifted and there is optimism and urgency again to become proactive with their financial situation. The rise was quickly followed by two days of market decline but the mood remained buoyant. Do these market moves warrant action by the investors on their portfolios?

While the relevance of a rise or fall in stock markets at any point of time is unique to your financial situation, here are five things you can do to negate the need to keep a constant eye on the market, to a large extent, and instead focus on your financial goals.

Assess risk appetite

Increasing your equity allocation just because the markets are suddenly looking positive may not be a wise move since it will increase the risk of volatility in your portfolio. If you do that, you may face the possibility of withdrawing at a loss if the market does a U-turn, unless you have a long investment horizon to wait out the decline. “Since we invest in line to a financial plan for our clients, the savings are assigned to goals and invested accordingly. There is no room for increasing or decreasing allocation to equity on the basis of market movements,” said Deepali Sen, a certified financial planner and founder partner of Srujan Financial Advisers LLP.

Similarly, exiting equity positions to book profits when markets are up may not help unless the portfolio needs to be rebalanced. “The allocations made to equity are linked to their long-term goals. There were some clients who wanted to book profits when the markets went up. We showed them how decreasing their allocation to equity now would have long-term impact on wealth creation as compounding benefits will be lost,” said Taresh Bhatia, a Sebi-registered investment adviser and partner, Advantage Financial Planners LLP, affirming the importance of staying true to asset allocation.

Why you can not trust the market in short term
Why you can not trust the market in short term

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Having a tactical portfolio not directly linked to goals may be one way to take exposure to equity, debt, gold or other investments to take advantage of market conditions. “For investors who understand the risks of equity and have attained a particular portfolio size, we offer the option of a tactical portfolio invested in direct equities to take advantage of market opportunities,” said Saurabh Bansal, founder, Finatwork Investment Advisor, a Sebi-registered investment advisory firm. “But this is limited to 10% of the portfolio,” he added.

Use your common sense

If it is time for you to rebalance your portfolio, don’t let the market decide whether or not you should book profits and restore balance.

An event that is seen as positive for equity markets may tempt you to stay invested to be able to participate in the expected gains. Or, a negative trend may encourage you to move to safer assets sooner than you need to. Both these may not work. Staying longer than you should in the hope of benefitting from an expected market uptrend may lead to losses; if the trend reverses, your money may get stuck when you need it. Similarly, exiting early may mean that your portfolio gives up on gains when markets rise.

“The fear of loss is more among first-time investors who have not spent much time in the equity markets to experience gains and losses,” said Bhatia. He believes that proper advice and education helps assuage the fears. The cue for rebalancing should be the needs of the goals and asset allocation and not the market levels. “Rebalancing happens to a plan and we stick to it,” said Sen. “It may be goal-led or every six months and we correct imbalances immediately, irrespective of market levels,” she added.

Rebalancing can be done in a way that allows you to benefit from volatility, especially while switching asset classes in response to the stage of funding for goals. Say, when goals are coming closer, the money should be switched out to less volatile investments. This can be done over a period of time to allow you to take advantage of any rise in price and reduce the risk of exiting at one point in time when markets are down.

Be realistic on returns

The 8% move up in the stock market indices over two consecutive trading days (20 and 23 September) did a lot of good to the returns from equity investments. However, to extrapolate these gains, or even some portion of the gains, to long-term returns expected from equity investments may be risky. Assuming a higher return than what the long-term average warrants based on short-term market movements may mean that you may fall short of the goal value that you are targeting.

“Setting realistic return expectations is important,” said Bansal. “The returns from equity will reflect the real GDP growth rate and expected inflation along with a risk premium. With the reduction in both GDP growth rates and inflation, the expected return from equity too has come down,” said Bansal, discounting the impact of market movement on setting return expectations for investors.

Never time the market

If there is one category of investors who felt vindicated with the rebound in equity markets, it is the disciplined systematic investors who kept their faith and invested through trying times without timing entry and exits into the market.

If you did try to predict the bottom before entering, you may have been left sitting on the sidelines and watched the markets soar. If there is money that has to be invested in equity markets which is typically for the long-term, then do it now, either through a systematic investment plan (SIP) or systematic transfer plan (STP) or as a lump sum, depending upon your comfort with the market levels.

If the market is in the initial phase of an uptrend or has corrected significantly, then it may make sense to invest a lump sum, provided there is positive economic trend to support market movement. If markets have already run up significantly and the economic trends are not favourable, then it may be better to systematically enter to minimize downside risk. Either way there is no sure shot way of eliminating market volatility and for investors who are there for the long haul, the intermittent advances and declines should even out.

Look at fundamentals

A bad stock or investment does not become acceptable just because the markets are booming or it is available cheap. Pay attention to quality, particularly when prices are going up across the board. There will be corrections soon enough and that is when poor quality will pay a bigger price.

“Volatility is an inherent characteristic of any market situation; but investors should have a long-term horizon and keep a close watch on factors such as the company’s growth, financial performance, visionary management rather than short-term price movement of a stock. Avoid the noise in the market and keep investing in a staggered manner to find stocks to benefit from,” said Arun Thukral, managing director and CEO, Axis Securities Ltd.

It is important to abide by investment rules, irrespective of whether there is exuberance in the markets or if the markets are in a downturn. It will help translate stock market movements into gains to your financial situation.

[“source=livemint”]