3 important decisions you should make in current time

By Arun KumarThe past six months are a gentle reminder to the simple fact that predicting the markets over the short run is extremely difficult. Period. 77990441No one would have guessed at the beginning of the year that an unknown virus from a small Chinese town would almost shut down the entire world and crash the equity markets by ~38%.Similarly, no one would have guessed that in the middle of all this, when our Indian GDP was down 23.9% for the June quarter, the equity markets would recover a whopping 50%, bringing it close to pre-Covid levels.We have always maintained our humble stance that we don’t possess any special abilities to predict the equity markets over the short term. Now that we acknowledge this, how do we go about managing your portfolios? Simple: we prepare. Ahem. Sounds pretentious, right?Before you write us off, let me explain what ‘prepare’ really means, when it comes to the actual execution. We boil it down to three important decisions that you should make at the current juncture.Decision 1: Get short term out of the way It is extremely hard to think about the long-term, especially when we are worried about near-term issues like our health, job, kids, family, money etc. How do we get through this dilemma?Start building an emergency corpus (via safe high-quality debt funds) to cover 1 year of bare minimal expenses (this means no swiggy orders, amazon sales, netflix, etc.)No or minimal equity allocation to portfolios built for the near-term goals (anything coming up in the next five years)The basic idea is that even if markets decline for some reason, you can comfortably reach all your near-term goals, without touching your long-term portfolio. In effect, you can provide the most important ingredient required for your portfolio to recover: Time.Once you take care of both your emergency corpus and short-term goals (without depending on equities), your money anxiety hopefully should be much lower.Decision 2: revisit your risk profileMost of you would have answered the boring risk profile questionnaires at some point in time and figured out your risk profile. In fact, your portfolios would have also been built on the basis of your risk profile.When it comes to risk profile questionnaires, I often get reminded of an insightful Yogi Berra quote: In theory there is no difference between theory and practice. In practice there is.The last eight months, though painful, provide us a great opportunity to find out our real risk tolerance. Here is a simple practical approach to figure this out. Take this quick test. What did you do in Feb-Mar 2020 when the equity markets fell by ~38%?Sold Equities: Implies low-risk toleranceHeld steady: Implies moderate-risk toleranceBought more: Implies high-risk toleranceBought more and hoped for further declines: Implies very-high-risk toleranceAs yourself, does your action match with your original risk tolerance? If no and it turns out that you panicked and sold during the fall, it means your equity allocation was way higher than your ability to tolerate volatility (read as sharp temporary declines).So, this is a good time to gradually reduce your equity exposure and bring it to the levels that match your risk tolerance.If you have not sold and your risk profile matches your current asset allocation, your original asset allocation was right, to begin with. You can continue with your original asset allocation. That is, you don’t need to go underweight or overweight equities. For a 50% equity allocation, simply stick to 50% and don’t make it 40% or 60%.Here is another quick test. Assuming the market falls from here for some reason, would you be willing to tolerate a temporary decline of, say, 20%, in your equity portfolio in the next six months?For example, let us assume you have a Rs 50 lakh portfolio split equally between equity (Rs 25 lakh) and debt (Rs 25 lakh). 20% of the Equity value of Rs 25 lakhs, works out to be Rs 5 lakhs. Would you be willing to tolerate ~Rs 5 lakhs temporary decline in your overall portfolio value in the next six months?If yes, then your current equity allocation is right for you and you can continue with it. If no and you are willing to tolerate declines but to a much smaller extent, then you need to immediately revisit your equity allocation and gradually bring it down.Remember that if you reduce your equity allocation you also need to be okay with lower returns over the long term. It is a simple trade-off. More the near-term pain you can take more the long-term gain. There is no right or wrong allocation. The ideal allocation is a portfolio designed to let you sleep in peace.Decision 3: prepare & plan for different outcomesNow that we are done with the short-term and have revisited our asset allocation to match our real risk profile, this leaves us with preparing for different market outcomes.1. WHAT-IF-THINGS-GO-WRONG planWhile we have no idea what the markets will do over the short-term, we always want to be prepared to make use of the opportunity if the market falls. A clearly defined plan helps us execute it during a fall without panicking.Here is how the plan (a rough plan that can be adapted to individual needs) looks:If Sensex falls to 32,000, deploy 30% of the money in equitiesIf Sensex falls to 30,000, deploy 40% of the money in equitiesIf Sensex falls to 28,000, deploy 30% of the money in equitiesFor example, In the Rs 50 lakh portfolio that is equally split 50% in equities (Rs 25 lakh) and 50% in debt (Rs 25 lakh), let us see how this works.Assume you have earmarked 10 lakhs of debt portion to make use of market falls: If Sensex falls to 32,000, deploy Rs 3 lakh in equities; If Sensex falls to 30,000, deploy Rs 4 lakh in equities; If Sensex falls to 28,000, deploy Rs 3 lakh in equities.2. WHAT-IF-THE-RALLY-CONTINUES Plan?This is a good thing as our equity allocation will continue to do well. In this case, we will continue to monitor the equity markets for valuations and earnings growth. If at some point in time valuations become extreme (indicated via MCAP/GDP, PB, PE, Earnings Yield vs 10Y GSec) we might look at reducing equity allocations. At the current juncture, we continue to maintain a neutral view and recommend sticking to your original asset allocation.3. Getting overly worried about a correction? ‘Sin’ a little…We have always warned you about the perils of market timing (trying to move in and out of equities) and the fact that there is no evidence of anyone consistently getting the market timing right.However, after seeing the sharp market rally, you might have this sudden urge to sell some portion of equities. No worries, welcome to the gang. This is precisely why we always emphasize on an evidence-based-process-oriented approach over emotional investing. So tempting as it may be, stick to your asset allocation as per the plan.That being said, at the end of the day as humans, we all have certain behavioral quirks that are difficult to get over with. Otherwise, we would have a world with only fit, super disciplined, super-productive people.As with most things in life, the trick is to ‘strike a balance’ and ‘sin a little’… if required. If you find it difficult to stick to your investment plan, don’t give up on it completely. Instead of reducing equity allocation and shifting to debt, take a mid-path solution by moving into dynamic asset allocation funds.The biggest issue with moving a portion out of equities is how to get back in. A lot of investors get it wrong and stay out too late as the markets always move ahead of the economy (remember what happened in the recent rally).Dynamic asset allocation funds can address this issue as these funds automatically adjust their equity allocation (reduce or increase), based on the market valuations.So, if you find yourself getting too anxious or confused about the equity markets, you can start moving a small portion, say, 10-20% of your equity allocation in dynamic asset allocation funds such as ICICI Prudential Balanced Advantage Fund, Kotak Balanced Advantage Fund etcetera.To reiterate, in our view, sticking to your original asset allocation will always remain the best solution. However, if you are not able to get over the anxiety and uncertainty regarding equity markets and have this urge to reduce equities, the mid-path solution of using dynamic asset allocation funds can be a good alternative, though it means sinning a little.This thought process can be summed up in our belief that an above-average investment plan that you can stick to is far better than a perfect investment plan that you will give up.Finally, while the temptation to time the market (read as moving out) is pretty high at the current juncture, long-term investment success finally boils down to simple and boring activities such as being patient, staying disciplined, and sticking to the long term plan.In line with our approach of favoring “preparation” over “prediction,” here are the three decisions that you need to make now:Get short term out of the wayRevisit your risk profilePrepare and plan for different outcomesHappy Investing, as always. (Arun Kumar is the Head of Research at FundsIndia.com)

from Economic Times https://bit.ly/2R8cBSA
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