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How did we lose so much in our mutual fund? What should we do now?
The conventional wisdom is to sleep on your investments and weigh out the bear. This strategy assumes two things, though. First is that you are guided by an asset-allocation plan that reduces risk through a balanced portfolio of stocks, equity and bond funds, and cash equivalents. Second is that the market fall has not altered those allocation. Now is an excellent time to examine your portfolio to correct imbalances and reduce risk. Following steps can help you be on course.
1. Don't hold too much of a single stock: When stocks rise, investors see little danger in owning too much of a good thing. But during the past year, the market sliced as much as 75% off stalwart stocks as Infosys, Satyam barring few. Too much of anything is your most vulnerable investment.
2. Sell off the stock in plenty: I would recommend selling off a part of stock till it accounts for no more than 15% of your portfolio and using the proceeds to buy diversified equity funds. Investors are reluctant to sell losing stock because that turns a paper loss into a real loss. But no one knows what the market will do, and your stock could fall further. If you're taking too much risk, you really need to scale it back now and not wait. How you loss you got is irrelevant compared to how you get out of the situation, which could be through a more balanced portfolio.
3. Give mutual funds their due: The historic boom in technology stocks till last year lured everyone -- even fixed income investors and investors with nothing, who borrowed to invest for greater returns. Today, with hindsight everyone realizes that losses can be greater too.
Recently I studied the performance of equity and technology funds and compared with individual stocks. The observation clearly shows the relative safety of funds. Past 1-year 33% of stocks lost half or more of their value last year. Whereas only two of the 96 equity funds (diversified equity including tax savers) lost that much -- ING Growth Portfolio (-53.7%), Dhansamriddhi (51%). Comparing technology stocks and funds also gave similar results. The average technology fund is down 45% over the past one year ending May 31, 2001. And look at the 1-Year returns as on May 31, 2001 from the leading tech stocks -- Visualsoft (-97.47), ITIL (-96.37), Satyam (-91.04), Mascon Global (-89.79), D S Q Software (-87.82), HFCL (-86.41), Pentamedia Graphics (-78.86), Global Tele-Systems (-77.42), Hughes Software Systems (-68.01), H C L Technologies (-64.96), Infosys (-45.82) and Digital Equipment (-7.14). And the average fall for these stocks is 75% in the past one year.
If the equity allocation of your portfolio is heavily skewed toward one sector, consider shifting to funds -- the sooner the better. A diversified equity fund can be an effective way to diversify.
4. Reduce your holdings in exotic but risky funds: Even when people stuck with funds during the long bull market, they tended to abandon conservative choices -- diversified equity and balanced funds -- to pile into tech-heavy highfliers. This worked wonders for a while, but now those erstwhile rockets have lost 40% or more.
If you think you can sit on your aggressive equity and technology funds for 5 years and more, then there is no reason to jump out of the fund now. You might get restless for a while, but eventually growth stocks will come back into favour, even if they never achieve the returns of the last year again. But such funds shouldn't dominate your portfolio. This doesn't mean selling them now. Rather, take up to 50% of your aggressive equity positions, and gradually shift those assets into well-diversified equity funds.
5. Don't panic and run away to cash: Hurt by the free fall, investors are giving up on equities and turning to bond funds and bank deposits. Unless you need the money, this is usually unwise, but more so now, with interest rates falling and the cost of living going up. The more bonds you own, the more you depress your long-term gains. Still, for some risk-averse investors, having an even larger allocation in safe investments may be right, till you're adjusting your risk to your ability to handle it.
If you do not need your capital for next 5 years and more, the market's big downdraft may provide a lesson. It's better to learn what too much risk can do to your portfolio and spirit when there's time to recover rather than when you need the money and your ability to recoup losses is severely limited.
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