Stock markets have been in huge turmoil over the past few weeks, of course, so have most asset prices. Recent green surges of limping economic activity following pandemic-induced shocks (initially demand, then supply) have been delayed due to the changing geopolitical environment. The Russian-Ukrainian conflict has not only created a political stalemate, but has also disrupted supply chains and access to some key minerals and food commodities. This situation is further aggravated by the already high prices of these items which fan new inflationary flames.
When the markets react to such daily changing news events, it is difficult to find a stable strategy to deal with these fluctuations. Even for seasoned investors, the sudden declines and ensuing volatility challenge their resolve. So, at such times, how should one approach investing. How should one react or respond to these dynamic changes in the market?
We’ve heard over and over again not to have all the eggs in one basket, the adage of diversification. In investing, asset diversification and therefore asset allocation is key, but how many of us duly follow this principle to the fore. Additionally, we have questions about how much to allocate to each of these assets and how to reallocate them from time to time depending on the market. Does it have to be done at all, in the first instance?
One should have a grip on oneself before even trying an asset allocation strategy. Indeed, everyone has their own way of allocating or even considering assets. For example, some do not consider real estate investment, whereas they would consider the allocation within financial assets. Ideally, it is better for an investor to take an overall view of the assets instead of focusing on sub-classes. Also, it is better not to consider the place of residence as an investment. With these basic principles, one could assess their current distribution of investments.
Keeping a basic asset allocation framework in place, i.e. 70-30 equity-debt or 60-20-20 equity-debt/gold-real estate, etc., helps get you started. Traditionally, Indians have carried certain notions towards real estate and stocks respectively that its scarcity hence the value would only appreciate and is volatile hence more risky or loss making. However, there is evidence that equities have provided the best long-term returns and remain transparent (in valuations) unlike real estate.
It’s one thing to have a strategy and follow it consistently. For example, when asset valuations rise, the overall balance can be altered, especially when assets are uncorrelated (also ideal). If the stock portfolio increases significantly within the portfolio beyond the defined proportion, then one could partially exit or profit from the book to maintain balance. What would happen if the exposure to real estate increased in valuations, if it was difficult to sell part of a piece of land or an apartment? Additionally, real estate valuations are tricky, especially when there is a dispute over open land or an unfinished apartment (if the builder defaults) and should therefore be valued at zero, at least, until the questions are resolved.
And if the stock portfolio is down, should more funds be added to the downside average. At first glance, averaging down seems like a smart move until you overdo it. By opting for a lower acquisition cost, one could unknowingly add too much exposure to a particular stock or sub-class of stocks, thereby distorting the overall allocation distribution and thereby increasing risk. Averaging down only because of the change in valuation is not a good idea, but if one were to observe that the reasons are not fundamental to the company or business, one could add more that business or action.
Thus, it can be difficult to always stick to this fixed allocation strategy or it can sometimes become impractical. Instead, one could try a more hands-on approach of goal-mapping or time-based investing. We know that each of the assets has its own cycles and one could play the game according to his own requirements.
For long-term goals like retirement, exposure to stocks and even real estate can help build wealth for the investor. Also, when investing, one should have a cash side share because one does not know when an opportunity arises. Notice that this is outside of the emergency fund which has an entirely separate function.
(The author is co-founder of “Wealocity”, a wealth management company and can be contacted at [email protected])