Studies have established that nearly 90% of an investment portfolio's returns can be attributed to asset allocation rather than individual stock selection. This emphasises how you distribute your investments among asset classes—such as stocks, bonds, and cash—which can significantly impact your overall financial success.
Mirae Asset Mutual Fund and Mint jointly organised a recent discussion, “Asset Allocation: the Modern Portfolio Theory.”
The event featured industry veterans Makhdoom Ansari, National Head of Retail Sales at Mirae Asset Investment Managers India, and Rajat K. Bose, a seasoned technical analyst and finance professor. The experts highlighted the significance of Modern Portfolio Theory (MPT) and explained how this theory serves as a guiding light for investors, offering strategies to navigate the delicate balance between risk and reward.
As emotions often cloud judgment while making investment decisions, understanding MPT becomes even more crucial. By embracing its principles, investors can diversify their portfolios effectively and resist the temptation of impulsive decisions, setting the stage for smarter investment strategies.
Here’s what the experts had to say.
Ansari opened the session by emphasising the critical role of mutual funds in personal finance. He stated that many individuals struggled with financial management and often lacked knowledge about effective investing strategies. He noted, "Many people saved a little from their limited income, and with those savings, they tried to tackle uncertainties in life," highlighting the common struggle of individuals trying to manage their financial future.
Mutual funds served as a professionally managed way to invest, allowing individuals to pool their money and access various securities, including stocks and bonds. “You’re not putting all your eggs in one basket,” Ansari noted. Diversification reduced risk—this was one of the core principles of MPT and something Mirae Asset followed in its investment approach. “The goal was to achieve a balanced portfolio,” he continued, “one that fit the investor's risk appetite but also provided a good return.”
He also underscored the simplicity and accessibility of mutual funds, stating that one can start a Systematic Investment Plan (SIP) in Mirae Asset Mutual Funds with a nominal amount of ₹99.
Rajat K. Bose elaborated on how MPT’s framework evaluated the optimal allocation of assets for better returns. “The basic premise is that risk is inherent, but if you diversify, you can lower it,” said Bose.
While MPT provided a clear, mathematical approach to asset allocation, Ansari and Bose emphasised how emotions shaped investment decisions. They discussed the heuristics and biases that often influence investment choices.
Bose elaborated on how investors often succumbed to mental shortcuts and biases, even when they understood the fundamentals of classical finance. “You could have all the knowledge about stocks, mutual funds, or market trends, but if you couldn’t control your emotions, you’d make impulsive decisions,” he explained. Bose emphasised the importance of behavioural finance, which challenged the notion that markets were always efficient and that investors always acted rationally.
"Fear grips you when you see a stock dip below your purchase price," Bose observed. This is where loss aversion came into play—the tendency to hold onto losing stocks simply to avoid the emotional sting of selling at a loss. “But once I learned to let go of those bad investments and focus on the long-term, my overall results improved. It’s all about resisting that emotional pull to act impulsively.”
Mutual funds offered a way to manage this. Professional management, diversification, and liquidity have helped reduce the impact of emotional investing. Investors had to stay calm and trust in long-term strategies rather than chasing short-term market movements.
Overcoming the tendency to time the market.
Mutual funds, according to Ansari, are a great tool to overcome these biases. “Instead of attempting to time the market or make emotional decisions, mutual funds offered the benefit of professional management. Experts handle the noise, allowing investors to focus on their long-term goals,” he said. He suggested that mutual fund managers could filter out much of the market volatility that drove individual investors to act on impulse.
Ansari shifted the focus to mutual fund allocation through the framework of Modern Portfolio Theory, emphasising the importance of asset diversification and strategic allocation. He began by defining assets—such as land, stocks, bonds, gold, and fixed deposits—as the foundation of an investment portfolio. "The combination of all these assets makes up your asset portfolio," he noted, highlighting the necessity of allocation, which refers to dividing total assets among various categories.
Ansari stressed that individual asset allocation varies based on risk appetite, investment goals, and time horizons. He asserted, "Life is about finding balance," indicating that achieving balance is crucial to mitigate risks associated with over-investment in a single asset class.
One of the core principles of Modern Portfolio Theory was diversification. “Diversification is key,” said Ansari, explaining that mutual funds lowered risk by spreading investments across multiple sectors and geographies. “Investing in just one or two stocks exposes you to higher risk,” he added. Bose emphasised, “Diversification didn’t mean just owning more stocks or bonds but carefully selecting assets that didn’t move in the same direction.” Both agreed that the right strategy balanced risk and return. “It was about constructing a well-rounded portfolio,” said Bose, “stocks, bonds, international markets, even real estate.”
Bose is a strong advocate of long-term investing. “Behavioral finance reminded us to focus on the bigger picture and not get caught up in day-to-day market fluctuations,” Bose said.
Ansari emphasised this point as well. He believed that long-term strategies, especially in the context of mutual funds, offered a better way to navigate volatile markets. "Instead of reacting to market swings, you should look at how your investments grew over the years,” Ansari said. “A disciplined, long-term strategy could help you avoid the emotional rollercoaster that came with short-term investing.”
As 2024 nears conclusion, investors face a complex economic landscape marked by interest rate cuts and geopolitical uncertainties, including the US elections. Recent market movements highlight the need for strategic asset allocation, with gold hitting all-time highs while popular equities face challenges. In this context, experts Ansari and Bose emphasise the pivotal role of mutual funds in achieving adequate diversification, helping to mitigate risks and counter emotional biases in investment decisions.
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