JOIN USIs it right time to diversify investment portfolio?
By Pratik Oswal
The stock market is grappling with a lot of volatility and investors have lost 20-30% of the returns over the last one to two months. With index valuations at historical lows - is it the right time to diversify investments?
But before, let’s explore a different perspective. At work and in personal life - most people feel the need to do something when things go sour. A work crisis leads to working long-hours and over-time to fix it. The same goes for the personal level crisis. But as counter-intuitive as it sounds - the correct thing is to not do anything during an emergency that impacts a stock or a mutual fund portfolio.
Diversifying a portfolio in a state of crisis is like buying insurance after your house is on fire. It’s a response too late.
What else should investors not do?
Do not sell: The power of compounding is something most people identify. It’s the basis for why most investors participate in the equity markets via stocks or mutual funds. But what most people don’t talk about is when compounding stops working. Compounding formula assumes that an investor is always invested. If an investor converts paper losses into real losses (by selling investments at losses), the formula breaks and that investor has destroyed his future savings in a big way.
Warren Buffett quotes are increasingly getting disliked, but let’s use it anyway. Buffett says, “Rule No 1 - Never lose money. Rule No 2 - Never forget rule number 1.” Converting paper losses into real losses is an example of an investor violating both rules above.
Don’t switch mutual funds: Never switch mutual funds based on performance. Every fund manager goes through periods of good and bad performance. Articles and blogs that start with “Top 10 mutual funds” is the worst thing that has happened to Indian investors.
Don’t over-invest: It may be tempting to over-invest in the markets today. Any investor looking at this from 2-3 year perspective will be happy to invest today. But it’s essential to keep liquidity in case the present solution worsens. It’s impossible to predict the future, and so it’s important to plan for it.
Don’t add too many new schemes: Having too many schemes is like buying the market. The portfolio will mirror the index
Don’t get lured by weak quality/penny stocks. There may be a temptation to buy penny stocks or poor quality stocks for the hope of multiplying money.
There is a very high chance of investors loosing out on all their money. If investors feel the need to diversify, diversify slowly. Investors should look to diversify their portfolio gradually over the next 12-24 months. Diversifying too quickly means investors will sell investments in losses. Add debt, gold, international funds so that your portfolio is ready for the next crisis (do asset allocation as per risk profile).
Why gold? Gold may not have high returns over long-term horizons but is a great hedge when equity falls. It will lower your portfolio volatility and give some bit of downside protection.
Why international funds? Geographical diversification will fight rupee depreciation and provide portfolio diversification. Did you know that if you were a US investor - your returns over the last ten years would be less than 1% CAGR?
In conclusion - is it the right time to diversify? No. But do it gradually over the next 1-2 years.
(The author is the Head of Passive fund Business at Motilal Oswal AMC)