Market pulse

Valuations within the Indian equity markets have turned expensive. The Nifty 50 is currently trading at a PE of 24.43, way above its long-term average. The Nifty Midcap 50 is trading at 55.22, and the Nifty Small cap 50 at 44.21.When valuations are so stretched, there is always the risk that any adverse news from within the country or abroad could cause the markets to tumble.

Here are points you can follow that will help you to navigate your way safely towards your goals in these markets.

1. Use SIPs: One precaution that mutual fund investors must exercise in expensive markets is to take the systematic investment plan (SIP) route for investing. This is not the time to make a one-time, bulk investment in equities, unless you are prepared to invest and forget the money for at least 10 years. The risk is making a bulk investment in an expensive markets is that if there is a correction, and you purchased units at the current high levels, it could take several years for your investment to recover their current value. With the SIP route, on the other hand, your investments tend to be staggered and you get the benefit of rupee cost averaging.

One more point to keep in mind regarding SIPs is that if you are using them to meet long-term goals, such as your child’s education or your own retirement, you should not stop them because the markets are expensive. If you do so, you may not be able to achieve these goals.

2. Build a diversified portfolio: One mistake that investors make when investing in a bull market is that they pour all their money into equities because of the prospects of making quick gains. The risk in doing so is that if the markets correct, their portfolio could register a steep loss in value.

Even in these times investors need to build a diversified portfolio, which means that they should have investments in equities, debt and gold (and also real estate). This will ensure that in the event of a market correction, the fall in the value of their portfolio is not very steep. To decide on their equity allocation, they can use the simple formula of 100 less age. So, an investor who is 30 years old can take a 70 per cent allocation to equities. If he feels that 70 per cent allocation is too little or too high, he can tweak the allocation a little, depending on his risk appetite (higher allocation if he has the risk appetite and lower if he doesn’t). The balance 30 per cent can be invested in fixed income and gold (in 20:10 ratio). While a diversified portfolio will rise less than a pure-equity portfolio during a bull run, it will also fall less during a market correction.

3. Rebalance periodically: On account of the bull run that is going on, your allocation to equities may rise above the level you had decided upon. In that case, you need to sell a part of your equity holdings and bring your allocation back to the pre-decided level. While selling, try to avoid paying tax and exit load by selling units that you have held for the long term. The money that you get from selling your equity holdings should be invested in fixed-income instruments and gold, so as to keep the allocation to all the three asset classes constant.

Besides inter-asset allocation, you also need to keep intra-asset allocation constant. What does this mean? Perhaps you follow a 70:20:10 allocation to large-cap, mid-cap and small-cap funds. Over the past two-three years, mid- and small-cap stocks have run up far more than large-cap stocks, so the weight of these funds in your portfolio would have increased. Once again, you need to sell a part of your mid- and small-cap fund holdings and buy more of large-caps.

Rebalancing should be done once every six months or one year. If you find doing all this by yourself complicated, take the help of a financial advisor. Finally, if you find selling assets difficult, you can also rebalance by investing fresh money in underperforming assets (instead of selling outperforming assets).

4. Invest for goals: Financial experts suggest that instead of being too concerned about the level of the markets, focus sharply on your goals. Each one of us has a few major goals, such as saving for retirement, saving for children’s education, etc. Build a separate portfolio for each of these major goals. Invest in the appropriate instruments, depending on the time horizon. If a goal is more than five years away, you may invest largely in an equities-based portfolio. If it is three-to-five years away, you may invest in balanced funds. And if the goal is less than three years away, you may make use of debt funds.

If due to the bull run in the markets, you have achieved a goal faster than you expected to, pull money out of equities and move it into debt, where your capital is safe. The same should be done if you are close to a goal as you don’t want a reversal in the markets to jeopardise your goals. The advantage of such a goal-oriented approach is that one avoids making speculative, short-term bets in the markets.

WORD BOX

Mistakes to avoid in a bull market

• Investing for quick and short-term gains
• Putting short-term money in equities
• Putting one’s entire portfolio in equities to maximise gains
• Betting more on mid- and small-cap funds that have run up faster
• If and when the markets correct, don’t exit in panic. Stay the course until your goal comes near