A practical guide to constructing a portfolio

We have seen the markets go through wild swings in 2020. Now, the upswing in equity markets seems to defy conventional logic with roaring IPOs and broader indices clocking good returns. There are however undercurrents of both nervousness (with the pandemic sill raging and economic recovery nowhere in sight) and FOMO (fear of missing out) on the part of retail investors.

While there is no Robinhood phenomenon in India, the question which remains unanswered is – is there a way to deal with the turmoil, protect some downside, and at the same time participate in the rally?

Before your advisor floors you with an “asset allocation” to generate an ‘optimal portfolio’ which is ‘diversified’, you want to understand how figuring out what we invest in effects our returns and how can we do it better. For the exceptionally long term.

First, determining what should exist in the portfolio is asset allocation - broadly what percentage should go into Equities, Bonds, Commodities (gold included), Real Estate, and others.

The next step would be to determine the instruments to take that exposure i.e. whether ETFs’ are better than investing directly in company share or mutual funds? Buying Government Bonds v/s bond funds or bond ETFs? Or even buying gold bars v/s gold deposits or even ETFs?

The ultimate choice of ‘what’ is determined by familiarity with the market, cost of buying/holding (ETFs are cheaper than Mutual Funds but require a trading account), and personal taxation. For example, listed securities (stocks, bonds, ETFs) are taxed differently than unlisted ones like mutual funds.

Now if all this sounds complicated, there are solutions in the form of investment advisors as well as platforms that allow you to do it yourself and those will get significantly better over time.

Platforms come with another distinct advantage: execution is usually a part of the offering and that brings us to our second problem: buying those investments. Staggering investments is good but smart SIPs’ are better.

After the initial corpus is deployed, use regular savings to rebalance rather than blindly investing in all markets all the time. This will allow you in those assets which are low and not invest heavily in overvalued markets.

The best part of this is risk does not go haywire with the kind of markets we have seen in recent months.

Lastly, now that we have all our investments all set up, we do need to manage those - which involves periodic reviews to determine whether we are on track or not? Both with regards to risk and return.

It would also be relevant to point out our own risk tolerance changes over time - age, change in employment, health, family situation, and other factors have a significant bearing on this. At this point, it is generally useful to consult with a professional to make changes, if any are required.

ETF’s have taken the world by storm and flows globally have been great.

These instruments lend themselves to asset allocation in ways that are significantly better than traditional investments and should be considered portfolio components.

Evolving platforms on the other hand are the more exciting recent development (with or without a traditional advisor) – those help plan, invest and manage at a lower cost and little commitment.

Recent SEBI order regarding allocations within multi-cap funds will have little bearing on a portfolio thus constructed while gaining from the possible short market displacement as managers scramble to realign their portfolios.

Volatility does not need to be a burden, with smart asset allocation (and management), you can make it work for you.