Throw away fear and greed while financial planning in 20193 min read . Updated: 02 Jan 2019, 02:47 PM IST
Don't buy the winners of 2018. Instead construct a well-balanced portfolio that can withstand volatility and give you a good average return
The year 2018 taught us that buying last year’s winner is not a good idea. Several years of good returns, a successful ‘mutual funds sahi hai’ campaign and the spread of the SIP culture brought plenty of first-time investors into equity mutual funds. The SIP book grew 50% over calendar year 2017 and another 20% in 2018 despite choppy markets. New investors rushed in and some of them went straight to the winners of 2017—the mid- and small-cap mutual funds. Some of these funds had given returns of over 40% in 2017 inducing investors to throw caution to the winds and rush to the risky part of the equity market. Investors made two errors. One, bought last year’s winner in 2018. Two, allocated all their equity investment to the past winner.
But 2018 saw the safe part of the market outperform equity with the PPF average return for the year outstripping the stock market by a fat margin. (To read this story by my colleague Sunita Abraham, click here.)
PPF returns of an average 7.70% and a one-year FD at 6.80% looked nice and fat when compared to the less than 2% return on the average large-cap fund. The safe part of the market looked even better when compared to the bloodbath in the average mid- and small-cap funds that lost just over 12% and almost 19% over the year. This freaked out some investors, who will probably want to rush back to safety of guaranteed returns, swearing never to trust markets again and blaming luck rather than themselves.
When Mint spoke to financial planners for our year-end special on how they handled volatility with their clients, most of them talked about having to hand-hold investors through stock market volatility with new investors more liable to needing the counselling than the older ones who had already been through one period of market volatility. New stock market investors who did not have the advantage of being with a financial planner were more at risk of rushing to buy the winners of 2018.
As investors, we need to understand that the returns on various products are due to reasons that can be beyond anybody’s control. For example, the fat real returns earned on the FDs, PPFs, MIS and post office deposits in 2018 are due to the Reserve Bank of India (RBI) keeping policy rates high anticipating inflation. But with inflation at an annual average of just 4.74% in 2018, the real return, or the return over and above inflation, was very high in the safe part of the market.
Usually these products do not give good real returns and just about keep purchasing power intact pre-tax. Remember that these periods of high real return do not last—either inflation rises or interest rates drop—causing real returns to drop as well. Also, unless it is a bear market that keeps stock prices depressed for years, prices bounce back once the market sees value again in the now-lower stock prices.
It would be an ideal world if we knew with perfect vision what the winning asset class of the new year will be and we can move all our money to that. How I would have liked to be fully in mid- and small-caps a few years ago! But nobody can predict returns across asset classes with perfect certainty. That is the reason we use diversification as a tool to have different asset classes that reduce the overall risk of the portfolio. Understand that you were not “unlucky" in 2018 and blame fate. Luck has very little to do with a long-term diversified portfolio-based investing approach.
Your money outlook for 2019 is very simple: learn from the mistakes of 2018 of buying last year’s winner and not diversifying your portfolio enough. Don’t buy the winners of 2018. Instead construct a well-balanced portfolio that can withstand volatility and give you a good average return. Throw away both greed and fear in 2019.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation.