Understanding your current financial situation (needs, time horizons… etc) and ascertaining your attitude towards risk is of paramount importance for making any investment decision. These two factors act as a guideline while establishing your financial goals and the type of investment you need to be making, to achieve those goal.
While setting your expectations from any investment, make a realistic estimate of the type of returns you expect from the investment. Past performance only provides an indicator of the historical returns and there is no assurance that the same would be repeated—which is more often than not the case. Future market conditions are impossible to predict and hence, you need to look at the following before setting any expectations:
Information is power
Information empowers you and gives you the extra edge while making investment decisions. Ask as many questions—after all, it’s your hard earned money. Make sure that you have all the relevant information and have understood it before making any decision. Here are some typical questions that you can ask before making any investment
Make an overall plan first, then choose specific investments
Make a financial plan first and then choose individual investments that fit into this plan—rather than making investments on an adhoc basis or by reacting to market conditions. A professional financial advisor can help you with both these steps.
Different investments make sense for different time horizons
Match your investments to the time horizon of your goals. For your long term goals such as retirement or children’s education, go in for equity funds which even though volatile in the short term are likely to give you the growth you are looking for. Similarly for short term goals, invest in money market or cash funds as they tend to be more stable and predictable.
Consider the time and effort that you are investing, besides the money
With each investment decision, recognise that there are varying levels of your effort and time that will be required:
Diversify... it pays
The importance of diversification cannot be overstated... It is a fundamental, long-standing investment principle. It helps reduce portfolio risk because different investments rise and fall independent of each other. One cannot eliminate risk, but diversification across asset classes, currencies and sectors can help in limiting the exposure to event and systemic risks. The combinations of these assets more often than not cancel out each other’s fluctuation, thereby reducing the overall portfolio risk. This is applicable to investments within an asset class as well.
For example, among equities, one can invest in large cap or mid cap stocks or invest in a single sector, and among fixed income instruments, there are choices of corporate/PSU bonds, government securities, floating rate instruments ...etc.
Understand the risk-reward relationship
All investments have a certain amount of risk, and normally, the rewards are commensurate to the risk you take. For example, equity funds do have the ability to provide good returns over the long term, but the question to ask is—Are you comfortable with the ups and downs of the markets? There is no point in investing your money in equities and spending sleepless nights due to short-term volatility.
But at the same time, you need to ensure that your investments provide you returns that will be adequate to meet your long term goals. In today’s changing environment, it is important to understand that risk is no more about having some degree of volatility in a portfolio... it is now defined as the possibility of investors not earning enough on their savings in their income earning years, and falling short of building the nest-egg required for a comfortable life in their golden years.
There is no “right” time
Trying to successfully ‘time’ the markets is next to impossible. Your investment decision should be based on the careful analysis of your situation rather than market conditions. It is important to remember that any short-term volatility you might face tends to smoothen out over the long term. Investing is not a 100-meter dash...it’s a marathon!
Moreover, when it comes to equities, investing in a systematic manner can help you capitalize on the ups and downs of the market. Mutual funds offer Systematic Investment Plans (SIP) under which you invest a fixed amount every month. Thus, when the markets are low, you buy more and when the markets rise, you buy less. This disciplined investment approach has proven to be a successful way of building wealth for millions of investors all over the world.
Keep your emotions at bay
Emotions tend to overwhelm us whenever there is a significant shift in market conditions or when faced with unforeseen circumstances, be it good or bad.
During euphoric market conditions, one tends lose sight of fundamentals and invest large sums of money in select sectors / stocks at one go. And given the cyclical nature of the markets, the overconfidence about the outcome based on market hysteria leads to non-diversification, and thereby affecting the savings pile adversely when the bubble bursts. This leads to investors now choosing to stay out of equities, which again is the wrong decision, as they would lose out once markets start catching up with fundamentals.
While making investment decisions during such situations, one needs to be even more careful. An objective and deliberate analysis of the situation, taking into consideration the investment objectives and time frame is an absolute must for achieving financial success.
Don’t be averse to taking losses
Most of us are reluctant to take losses, which means admitting to mistakes. Until and unless you have a good reason to be optimistic about the future prospects of a loss-making investment, just sell it. We all make mistakes, the point is to learn from them and not live with them.
Stick to your plan but review it
Before making the investment decision, evaluate how it affects your current asset allocation plan. As time passes by, your life stage changes and so do your needs as well as income. You need to periodically monitor and review your investment. You need to ask questions like:
The writer is the president of Franklin Templeton Investments (India).