Currently, many of us investors in stocks (or equity mutual funds) find themselves in the midst of a situation where we wake up at night and start worrying about how stock prices have gone up. over the past few months. For many investors, the period since last February when the Chinese virus hit hard has been an emotional roller coaster. First panic, then relief, then excitement, then overexcitement, and finally, growing unease. Could this be real? Will the stock markets move higher and higher, on the path of a strong and deep bull run that will last for a long time, or is fate imminent?
My answer is that in the short term, any answer is a guess. In the longer term, stock prices will rise more and more. To explain why I am saying this, I will just say that this is the exact answer I gave someone in mid-2004 when I was asked that now that the Sensex has hit 5,000, it doesn’t. surely couldn’t go much higher. It’s an evergreen answer because it’s still true.
However, back to asset allocation and asset rebalancing. The only solution to the above problem is to have a predetermined asset allocation and not stray too far from it. Let’s recap the basics. Asset rebalancing means that instead of seeing the equity vs. fixed issue as a black vs. white binary choice, you should see it as a shade of gray. Once a year or so, you might ârebalanceâ your portfolio. This means that if the actual balance has moved away from what you wanted, you need to transfer money from one to the other in order to reach that percentage again.
When stocks are growing faster than fixed income, which you would expect most of the time, you periodically sell equity investments and invest the money in fixed income to restore the balance. When equity starts to lag behind, you periodically sell some of your fixed income securities and switch them into stocks. This beautifully implements the basic idea of ââmaking a profit and investing in the downed asset. Inevitably, things turn average again, which means that when equity starts to lag behind, you’ve shifted some of your profits into a safe asset.
However, there is no need to over-intellectualize this whole thing. There is no practical difference between 35 and 40%. My idea has always been that there are only three equity-to-debt allocations possible. They are: 1) A lot of fairness; 2) Lots of fixed income; and 3) A balance between equities and fixed income securities. Sounds hopelessly vague, doesn’t it? In fact, it has all the precision you need. Practically, I would define it as 25%, 50%, and 75%. However, you can adjust it if you think it should be something else. Someone who wants to start making money, with very little debt in life, might aim for high equity. As life progresses and you approach retirement, or there are other issues that you foresee, move towards balance. Then, as the end of your working life approaches, move on to the other side.
If you’re right, it doesn’t matter whether the markets crash or explode in the next few weeks or months. You will have avoided the regret of doing the wrong thing at the right time.
Read also :
Why rebalancing the investment portfolio is a pressing need; how to do
Read also :
Sensex at its highest: is it time to rebalance your investment portfolio?
(The author is CEO, Value Research)