How often do you churn your investment portfolio? On what basis do you do that? On the basis of market sentiment, right? As & when you feel the bull is running you just close your eyes & run after it & then when the bear phase comes you just hide yourself completely getting out of the markets. I am sure most of you would have increased your exposure indiscriminately to equities at around 18, 000 to 21, 000 levels & then would have feared & not invested anything at 8, 000 levels. (Only if you would have done the reverse I would have not had to post an article on it.)

So, how & when should one invest? The answer is by following a disciplined format which should be laid out in an INVESTMENT POLICY STATEMENT (IPS). This is an important written document that clearly defines your objectives and constraints over a relevant, explicitly stated time horizon. The IPS is the linkage between you, the financial planner, and your portfolio.

A properly constructed IPS provides support to follow a well-conceived, long-term investment discipline, rather than one that is based on unplanned revisions produced by overconfidence or panic in reaction to short-term market fluctuations. If you don’t follow the IPS route you may end up rebalancing your so called asset allocation in a faulty manner. The absence of written policy reduces decision making to an individual event basis and often leads to chasing short-term opportunities that may detract from reaching long-term goals. The presence of policy encourages one to maintain his focus on the long-term nature of the investment process, especially during turbulent or exuberant times.

Each IPS discusses investment objectives, addresses the client’s risk tolerance, details the time horizon and asset allocation for the portfolio and identifies other concerns and wishes of the client. It also outlines the procedures that will be used to implement the investment strategy. An Investment Policy Statement serves to instill discipline into investment decisions by clarifying the decision-making process that will be used as the investors money is put to work. It should also identify how often the portfolio is monitored and what rules are to be followed when rebalancing the allocations.

How to decide the Asset Allocation under IPS?

Asset allocation means diversifying your money among different types of investment categories, such as stocks, bonds and cash. The goal is to help reduce risk and enhance returns.

This strategy can work because different categories behave differently, Stocks, for instance, offer potential for both growth and income, while bonds typically offer stability and income. The benefits of different asset categories can be combined into a portfolio with a level of risk you find acceptable.
Establishing a well-diversified portfolio may allow you to avoid the risks associated with putting all your eggs in one basket.

Asset allocation decisions involve tradeoffs among 3 important variables:
• Your time frame
• Your risk tolerance
• Your personal circumstances

Depending on your age, lifestyle and family commitments, your financial goals will vary. You need to define your investment objectives—buying a house, financing a wedding, paying for your children’s education or retirement. Besides defining your objectives, you also need to consider the amount of risk you can tolerate.

For example, when you retire and are no longer receiving a paycheck, you might want to emphasize bonds and cash for income and stability. On the other hand, if you won’t need your money for 25 years and are comfortable with the ups and downs of the stock market, a financial advisor might recommend an asset allocation inclined heavily towards stocks.

Understanding the importance of discipline in investing:

Let’s consider that after analyzing your risk profile & other objectives your initial asset allocation is decided at 60:40 in equities & debt respectively. That means out of every Rs. 100 you invest, Rs. 60 goes to Equities & Rs. 40 to debt. Now let us see how your returns are affected by comparing the two investment strategies.
1) Maintaining your asset allocation as per the Investment Policy Statement.
2) Changing your asset allocation on the basis of market sentiment.

1) Maintaining your asset allocation as per the Investment Policy Statement.
 
As per your IPS you will have an asset allocation of 60:40 & review your portfolio after every 3 months. If there is a major change you will rebalance your portfolio. How? Check this out. 

(Figures are approximate & imaginary)

So, effectively in a span of 6 months though equity value is at the same level your overall portfolio has risen 24%. i.e. Rs 100 has grown to Rs. 124.

2) Changing your asset allocation on the basis of market sentiment.

 Now other things remaining the same lets see what value would your overall investments be if you change your asset allocation on the basis of market sentiment.

(Figures are approximate & imaginary)

Here effectively after 6 months along with undue exposure towards equity your overall portfolio rose only 9%. i.e. Rs. 100 grew only to Rs. 109.

I hope the above example has explained you the importance of following a disciplined approach towards your investments.

Now if you feel that its human tendency to get carried away with the market flow then I give you an easier option. INVEST THROUGH BALANCED MUTUAL FUNDS. By investing in both shares and fixed-return investments, balanced funds seek the best of both worlds. They include the power of equities (shares) and the stability of debt market instruments (fixed return investments like bonds) and are most likely to take you to your goal safely. They are the best hope for those who want to benefit from the stock market but don’t have the stomach for volatility. An average balanced fund maintains a 60:40 equity debt ratio. That means 60% of their total investment is in equity and the balance in debt.
 
In a booming market, even these funds cross the 60% limit in the search of higher returns. And, if the fund manager makes a few wrong investments, the fund’s returns may go for a toss. But, balanced funds have proved their worth time and again and rewarded investors with superlative returns and stability. The returns may not be as flashy as diversified equity funds, but balanced funds are the ultimate vehicle for long-term growth for conservative investors. They will save you from bumpy rides and ensure a soft landing.
 
The three best funds in this category are:

HDFC Prudence.
Principal Child Benefit.
Reliance Regular Savings- Balanced.
Don’t run after the market. You walk in your own pace the returns will follow…………..

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This entry was posted on Thursday, July 16th, 2009 at 12:43 am and is filed under Mukesh Dedhia's published articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.