This election season, don’t let market volatility and the ensuing noise around it distract you from your asset allocation and financial goals
Staying invested can reduce the variation between the highest and lowest return you may earn on your investment
Is the general election an event that warrants a realignment of your investment portfolio? A quick poll among financial advisers indicates that while investors are ready to accept the wisdom of not allowing short-term events dictate the course of a long-term investment portfolio that’s carefully constructed keeping the financial goals in mind, they may be tempted to make tactical changes to protect their portfolios.
We culled out four rules after speaking to financial advisers, sticking to which will help you stay the course amid short-term volatility in the market caused by events such as the elections.
Have a plan and process
Having a plan can help you remain focused on what you have set out to achieve. A portfolio that is not working towards the goals identified in a financial plan is likely to go off the rails at the first sign of uncertainty.
This happens when there are no pegs to keep you anchored to your saving and investment plan. For instance, an equity portfolio that is moored to building a corpus for your child’s education 15 years later helps you ignore fluctuations caused by near-term events. You continue to invest since you don’t need the funds immediately. If you do not have that or a similar peg, you may be tempted to stop or even exit investments when you anticipate volatility.
“Once a portfolio is built to a plan, then it needs to be tweaked only when there is a change in the essential features of the plan itself, such as a change in the goal or the ability to save," said Naveen Rego, an investment adviser registered with the Securities and Exchange Board of India. Automating your investments is one way to do this. Avoid procrastination in making investment decisions, especially in an uncertain investing environment.
Focus on allocation
The temptation to switch to safer instruments during market volatility is always high. But this is when you need to remember that investing is about asset allocation—as long as your asset allocation is in place and there is no change in your risk tolerance, there is no reason to alter it.
Tactically reducing the allocation to equity, independent of the needs of your financial goals, may do more harm than good. Also, timing the market by shifting out before the elections and moving back when markets show signs of recovery is not advisable. To be able to do that, you will have to get market timing right twice in a short time frame and that is a tall ask which may not even be worth the trouble.
Staying invested has the advantage of reducing the variation between the highest and lowest return you may earn on your investment. For a five-year holding period in the Sensex, the maximum you could have earned was 47.64% while the minimum was -5.08%, a gap of 52.72 percentage points. This would have narrowed to 12.83 points for a 10-year holding period with a maximum of 23.18% and a minimum of 10.35%. For a 15-year holding period, this difference would be only 5.35 points with a maximum of 16.41% and a minimum of 11.06%, bringing greater predictability to the return expectations.
Take a long-term view
That equity is meant for the long term is an oft-repeated rule. Here is the proof: historical data of the returns from the Sensex, from inception to 31 December 2018, shows that for any seven-year holding in this period, you would not have made a loss. If you remained invested for another year—eight years—then you would have made a minimum return of 6.97% across any eight-year holding period since inception, enough to beat inflation. A 10-year holding period would have given you a minimum of 10.35% over all 10-year holding periods and a maximum return of 23.8%. If your holding period is just five years, then there is an 8% chance of your investment portfolio generating negative returns.
The data makes the answer simple: put your election worries aside and focus on equity for long-term goals.
Rebalance if you need to
While it’s a bad idea to touch your long-term investments in reaction to short-term events, a periodic review of even your long-term goals is essential to rebalance the asset allocation if it has moved away from the preferred proportions. Choose a date and month on the calendar every year, when you sit down to take stock of your investments.
For example, if the proportion of equity in the portfolio has gone below the preferred allocation, you may be tempted to let things be if you believe that the election outcome is going to be negative for equity markets. If you don’t rebalance your portfolio to bring equity back to its appropriate levels, as a long-term investor you may miss out on an opportunity to buy into equity at lower prices. Also, you may have to invest much more to correct the allocation later if you wait till markets show an upward trend. Similarly, don’t ignore exiting from equity into more stable assets in a phased manner if your goals are closer even if you expect the market to rise after the election. You may find yourself unable to fund your goals if the markets decline instead. These are regular portfolio maintenance jobs that you should not ignore, irrespective of the elections.
Vikram Krishnamoorthy, founder and investment adviser, Insightful.in, a financial advisory firm, believes in passive long- term investment plans for his investors. “Investors’ portfolios are rebalanced in response to the impact of market levels on the preferred asset allocation. The election is just one more event that may have an effect on the level of the market," he said.
Remember that different election outcomes may have different consequences for the equity market, but that should not affect your ability to take risk.
Risk tolerance depends on factors such as the tenor of your goals, demographic factors such as your age, and the stability of income and savings, among others. A temporary external event, like an election and its outcome, will not impact the extent of risk you can take, and allowing it to trigger a change in the asset allocation may be detrimental to your financial goals.
What should you do?
There is no one-size-fits-all advice, and individual profiles can be sliced in many ways leading to infinite situations and solutions.
If you are completely risk-averse, move out of equity for all goals with a time horizon of less than seven years, which is the minimum holding period where there was no negative return from the equity markets (see graph). But this may be an unrealistic proposition and most investors may be willing to trade safety for better returns.
If you can take some risk and your goal timeline ends in the next three years, then your funds should be in assets with stable values. If they are not, then accelerate your systematic exit out of equity and into products designed for stability, such as short-term debt, rather than growth.
If your goals are four to seven years away, then you need to ask some questions to assess your situation. Can these goals be postponed if the funds are not immediately available? Is there another source of funds you can tap into, if necessary, to fund these goals temporarily? Can you fund the goal in tranches over a few years, like education fees, where some portion of the funds can come later? If the answer is yes to any of these questions, then you are probably in a position to continue holding some portion of your corpus in equity and manage to meet your goals even if there is a temporary dip in your equity holdings. Data on past returns from equity markets shows that while there is a 13% chance of making a loss in a four-year holding period, this goes down to 4% for a six-year holding period. For a holding period of seven years or above, there is no risk of loss and the corpus can be held in equity.
While large-scale changes to your investment plan is not the way to deal with event-based volatility, it is okay to make a tactical tilt towards lower risk for incremental investments till the muddy waters clear.
Stay with systematic investment and transfer plans to make and redeem investments. You can make small alterations even within an asset class to manage risk. For example, increase the allocation to large-cap segment and postpone any addition to mid- and small-caps at this stage. In debt, short-tenor funds should be the focus. More conservative investors can buy fixed-income products in case they are offering a good yield.
Sometimes not reacting to an event is the best strategy for your money life. Tune out the deluge of information that is coming your way this election season, and instead focus on staying the course.