Don’t put your eggs in one basket- else whatever happens to one investment, that becomes your future.
Let’s assume for a moment that you’ve created a portfolio which goes up by 10% when the market rises by 10% and falls by 10% when the market falls by 10%. The market we’re talking about here is the stock market, which sees volatility or changes on a daily basis. The fate of your portfolio is truly and completely linked to your fate here. Ideal scenario? Hardly.
The next scenario is that your portfolio is created with only fixed deposits and that these deposits return 7% per year. If inflation is at 5% and the interest is taxable at your tax bracket- which for simplicity sake, let’s say is 20% – your actual return is 5.6%. This means that you’re barely making anything above inflation (and not to talk about education or health care inflation which is much higher).
So, what should you do? If you choose only growth, like in the first scenario, you are doomed to sleepless nights worrying about a volatile portfolio and if you choose the second scenario, you don’t grow your money enough to make an income stream for you.
So let’s see if there’s a third scenario where you opt for a combo to get the best of both worlds – growth and safety. Everyone likes combos, be it at McDonalds’ or in portfolios. They can be money savers or money makers. But for this, you have to know what you need. List down a few events in your life that will need money to accomplish- your vacations, your children’s school fees, your home, your new car or anything at all.
First, keep at least 3 to 6 months of expenses in liquid mutual funds or your bank account to ensure that it is available at short notice and will not go down in value. Then, we diversify the portfolio primarily into equity and debt. You can also look to add gold for upto 10% of your portfolio. Why diversify?
1. We don’t know which asset class will perform best this year and so, it is good for us to have investments in more than one asset class so that we don’t leave it to chance.
2. Don’t put your eggs in one basket- else whatever happens to one investment, that becomes your future. It shouldn’t be a ‘hit or miss’ scenario.
We control our risks by diversifying.
But only diversification isn’t enough, we need to rebalance our portfolios periodically. Once in six months, see how much your portfolio has moved away from your ideal asset allocation. If you had started off with a 50:50 allocation to equity and debt; and it has moved to 60:40 due to fresh investments and the market movement; bring it back to 50:50; this is a smart way also because you remove the emotion out of investing by booking profits when markets are moving up. When markets move down, you will adjust your asset allocation and when you do that, you will move more money towards equity and; so you will invest when valuations are cheap.
You will then be not only a disciplined investor but a successful one too; because you’re following a system and removing your emotions and biases out of the decision making process.
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