Widely read:
Right now, a lot is happening: Indian elections are approaching, there's a war brewing in the Middle East, and all of these things have a bearing on market sentiment and, in turn, on your investments. This is a time when many investors are agitated or curious about what they should do. So, is there anything that you need to do? Is there a checklist that you need to prepare? We'll discuss that in today's episode with Dhirendra Kumar.
So, let's begin today's conversation. With so much noise around us, what should an investor do in such times?
One question to ask is whether you should do anything at all. If you're on a good plan—for example, if you are someone who started investing a year ago, chose a couple of flexi-cap funds, and have stuck with it—you should do nothing. You don't need to if you have two flexi-cap funds for a Rs 10,000 SIP. If you started investing a couple of years back, entered the market randomly, invested as the market kept going up, and were excited by the "Mutual Fund Sahi Hai" campaign, and now you're sitting on a profit. Not only that, most people also end up being collectors; you had this fund, that fund, that NFO, and you kept on buying.
Buying mutual funds has also become easy. If you're with a collection of funds, maybe sharpen your portfolio. Ask yourself what you really need, set up your portfolio on Value Research, and see if you have too many funds. For those who have accumulated something meaningful—assuming you have been making your investments for the last 10-15-20 years, and it has accumulated to something on which your retirement or a lifetime of income will depend—you need to do something about it because it will be very unnerving. A couple of things to do: one is to first reorganise your portfolio. The second is to set up an asset allocation; fix your asset allocation. You have to decide at this stage whether you want to be 75 per cent into equity, or 100 per cent into equity, or 50 per cent into equity, because until you decide this, how will you make sure that you need to do something about it? You have to do some course correction. The advantage of asset allocation is that it gives you an opportunity to rebalance. This will have two effects. Firstly, when you do this—asset allocation and cleaning up your portfolio—you are much more in control of what is going on. Secondly, if the market goes down, you will get an opportunity to invest, and you will have a framework to invest. Otherwise, if tomorrow the market goes down and you're fully invested in equity, you will only have regret and you won't have a framework. So, asset allocation and rebalancing is basically creating a framework for you to act in a logical manner.
You mentioned asset allocation. Usually, most investors have their investments scattered across a lot of instruments: there are mutual funds, stocks, EPF, and many other instruments. So, how does one really know what their accumulation is, and how then to go about asset allocation?
One way is to start at a different level of sophistication. You can just pick a piece of paper and write down how much is in your EPF, how much in your equity fund, how much in your debt, how much in your fixed deposit. Do a sum total of all this and see what percentage is what, because everything should boil down to equity, debt, or commodity. You will figure out what your asset allocation is. The more sophisticated, or the smart investors, do this: they come to Value Research, put all their investments there, including fixed deposits, bonds, shares. The advantage of doing it on Value Research Online is that you not only know what your asset allocation is, you also know how much is concentration and how much is real diversification, because diversification is just as important. If you think that you have invested in equity and that all things are sorted, no, they are not sorted. You have to make sure that you're diversified enough and you're not too diversified. So, you have to strike a good balance, and that typically happens when you just randomly go about collecting investments over a long period of time, and there is nothing wrong with that. But there comes a time when you should actually sharpen your portfolio, formulate some rules, and the first rule is to remain diversified. The second is to actually have asset allocation. The third rule is to decide when you will rebalance. Assuming that you have decided to have an asset allocation of 50 per cent equity, 50 per cent debt, and you're 10 years away from your retirement, five years away from your retirement—whether the 50 per cent becomes 55 per cent and the debt becomes 45 per cent, will you do a rebalancing? Or when it becomes 60 per cent equity and 40 per cent debt, then you will do rebalancing. So, formulating your own rules is important because it will give you some discipline. Also, I think that it'll be very profitable and it'll reduce a lot of anxiety, because every time the market goes up, you will feel happy, if every time the market goes up, you will be realising a bit of gain, but you will not be acting in a knee-jerk way. My worry about most investors is that they, when they panic, act in a manner which hurts them in the long term.
You mentioned diversification. How do we know what is the right diversification? What is the right formula for that?
Good diversification can be achieved with something like 30-40 stocks. A good diversification can also be achieved with even one fund. In fact, one good asset allocation and diversification can be achieved with an aggressive hybrid fund because it will maintain an asset allocation of 75-25 per cent (equity-debt). Not only that, it will keep rebalancing without any tax incidence. Then the equity portfolio will be spread over 30-40 stocks. at least. The fixed income portfolio will be spread over multiple bonds. So, a good diversification can be achieved with one fund, can be achieved with a couple of multi-cap funds, can be achieved with 30-40 stocks, but having 10 funds is not going to serve a purpose. Once you have investments, mutual funds crossing 10, you are not interested in any, and when something slips substantially or when something does very well, it has no corresponding effect on your net worth. It is very important for investors to be interested in the investment that they have made. And with that, I think that great diversification can be achieved with three or four funds. And great diversification of an equity portfolio can be achieved with 20-25, 30-40 stocks at most.
Okay, then, how does one go about judging the quality of their investment? What's the criteria?
This is where Value Research comes into play very meaningfully. In fact, recently we launched something called Stock Rating. And I would say that don't go out micromanaging, but I would say that if a fund slipped from five stars to four stars to three stars, keep watching—at least you have been alerted. On a risk-adjusted scale; the fund is slipping, and that is why there's a decline in the rating. And once it slips below three stars, start asking why it is happening. Is it because the fund manager has gone away? Or is it taking too much risk? Or is it something else? You will be able to figure it out, so I would say that good investment, bad investment—you will get excellent prompts at Value Research. Another thing is that you have to see how much to worry. Many times I find that one investor will invest 2 per cent in an investment, and it is the most volatile one; he is very excited about it. And that excitement does not correspond to the proportionate joy of building wealth or being well-off. Have meaningful exposure. And that can be done with either one fund, two funds, or four funds, and that is it. And when it comes to mutual funds, five is enough, unless you have some extraordinary case, maybe go with a sector fund or go with a thematic fund or go with something which has come your way, and you're very convinced, but you don't know which one to sell. But keep an eye, don't have 20, don't have 30. Don't become a collector.
So, how does one prune their portfolio?
We can't really help you find great winners; we primarily help you avoid the big losers. So, if a fund is consistently one star or two stars, and for a couple of years, get rid of the losers, and the rest of them just for sake, unless you have some 10-15-30 per cent exposure to have your total equity exposure, consider selling them. If the fund has turned bad, if the fund manager has quit, if the fund has started behaving in an erratic manner, if the fund has some qualitative thing has changed, for example, the fund was doing very well, and now that fund has become so big that it struggles to do well, and the dynamics of that fund have changed. So, you will have to read a little bit. When you have meaningful exposure, you are interested and then you are interested in learning a little bit more, not too much of learning, but understanding what is going on. And is it alarming? Because many times nothing is going on; it has just not gone out of favour, the portfolio remains the same, it is not doing as good as it did in the recent past and you can't do much about it and then it will do well again because most parts of the markets are cyclical.
What should be the limit to your exposure to one fund house?
These are other levels of diversification, because I would say that there is no limit till you are in your first few years of accumulation because if once you are investing in one fund and your accumulation is a couple of lakh rupees, but it is very insignificant, because initially as you take that, your savings will increase, you will invest more, and it will do well. Only once it becomes meaningful. And I would like to define what is meaningful: meaningful is the worth of your investment, which is equal to 10 years of your monthly savings. If you're saving something like Rs 10,000 a month, which is Rs 1,20,000 a year, which in the last 10 years has appreciated to Rs 40 lakh, then that is meaningful because it is 10 years of your hard work and the residual of that. So, that is the money which you should worry about. And that should be spread over four funds, and good funds at that, so that you know, because some of the great fund managers also go out of favour. But if you're invested in just one, the great one, and he goes out of favour, then you are in trouble. You're not only in trouble, you cause a great deal of anxiety. By investing in a mutual fund the way you diversify, it reduces risk, it reduces anxiety, and you are more likely to stick around, which is the most crucial thing to succeed with investing.
All right, now to sum it all up, if you had to give some must-do pointers to people to prune their portfolios, what would they be?
Define what is too much diversification. If you have SIP going on in 15 funds, pick your winners, stop the others, reduce it to four or five.
Second, get rid of the poor ones. If you have accumulated something sizable, decide on the asset allocation, work on the rebalancing plan, and even your debt allocation. Take a holistic view of your investments. because many times, your accumulation in your provident fund might be Rs 1 crore, and you have invested Rs 10 lakh in mutual fund, and you're obsessed about it. It doesn't matter. It's just 10 per cent of it. So be rational about this, keep an eye, take a holistic view of things, and when deciding on the asset allocation and rebalancing, take everything into picture, take a 360-degree view of all your investments.
One more thing, you don't have to get carried away by the noise. You are investing for the long term. And every five years there is an election, every now and then there is a war, and every now and then, you know, we don't know how the war will escalate and what impact it will have. What you know, control the controllables: you have control on your savings, you have control on your investments, you have control on building a portfolio that is sharp and good enough and you believe in it. So focus on that, and let the other people let the warriors do the war and you know, and the politicians do the election.
Additionally, the Indian market has become more stable, not as vulnerable to foreign investors' actions, but don't bank on that. Investors' minds are very malleable; people can get upset even when we get the same government back, but with fewer seats or fewer than expected seats, because the market is a complex cocktail of so many opinions that it is very difficult to anticipate in the short run. What you can be very confident about in the long run is that things look unusually optimistic, things look very fine. And markets are not, you know, very expensive. If you stick to a plan, you will end up being a winner.
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