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As 2021 offers hopes of getting back to normal life after the pandemic, this can be a great time to revisit your investment portfolio. Here is a simple six-point checklist:

Do you have an emergency fund to tide through emergency situations? Last year was a good reminder of the need for an emergency fund. Make sure you maintain around 6-12 months of your expense money in a safe debt fund or a fixed deposit.

Is your current asset allocation mix in line with your original plan? Given the recent equity rally, there is a good chance that your equity allocation is much higher than your original planned asset allocation. If your equity allocation exceeds the original asset allocation by more than 5%, it’s a good time to book some profits and realign them back to the original allocation.

Are you adequately diversified across different investment styles in your equity portfolio? The past few years have favoured the quality style and global equities. There is a good chance that you are over-allocated to equity products from these investment styles if you only went by past returns. Diversify equally across five investment styles—quality, value/contrarian, growth at reasonable price, mid & small cap and global equity—to create a well-diversified portfolio with low portfolio overlap.

Does your debt portion carry interest rate risk and credit risk? Duration risk and credit risk are legitimate ways for debt funds to increase their returns. However, they also come with risks. Credit funds have two major risks...

1. Credit risk: The risk of a net asset value (NAV) decline if underlying bonds default or get downgraded.

2. Liquidity risk: Given that lower credit quality papers cannot be sold easily in Indian bond markets, unexpected redemption pressures from investors can lead to closure (remember the Franklin saga?) or sharp NAV falls due to distress sale.

Similarly, funds with a higher duration run interest rate risk—the risk of a higher NAV decline if interest rates move up. Given that most of us view debt funds as an alternative to fixed deposits, the majority of your debt exposure should be in funds with low duration (less than three years to reduce interest rate risk) and high credit quality (>95% AAA and equivalent exposure to avoid credit risk). Even if you want to take interest rate risk or credit risk to improve returns, it is better to limit these risks to less than 30% of your overall debt exposure.

Do you have the right return expectations? Going forward, as interest rates have come down, your return expectations from both debt funds and fixed deposits should be much lower compared to what you enjoyed over the past three-five years. For debt funds, the return expectation should be centered around the current yield to maturity adjusted for expense ratio.

For equity markets, given the high valuations at the current juncture, the next three-five-year returns will be predominantly driven by the underlying earnings growth. While the past five years have had paltry earnings growth, it is reasonable to expect above-average earnings growth over the next five years.

This view is driven by early signs of economic recovery, no visible second wave of the virus, low base, cost-control measures from corporates, low-interest rates, government reforms, etc.

On the volatility side, while it is impossible to forecast, based on past history, a 10-20% intra-year correction is almost a given and should be considered to be normal equity market behaviour if at all it happens. If markets fall more than this, then this can be a good opportunity for increasing your equity allocation.

If markets fall, do you have a ‘what-if-things-go-wrong’ plan? Instead of making investment decisions in the middle of a market fall, a pre-loaded decision plan is a good way to approach the situation. Pre-decide on a portion of your debt allocation to be deployed into equities if in case the market corrects.

The above six checks can ensure that your portfolio is well-prepared for handling whatever 2021 has in store for all of us.

Arun Kumar is head of research, FundsIndia.

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