The recent fall in the equity market has highlighted a different character of retail investors. Contrary to the earlier perception that retail investors are the last to join and the first to leave, this time they were clearly the first to join the party when their institutional counterparts were still sceptical. There were instances when retail investors were nimble enough to spot opportunities in the equity market, investing in a staggered manner. This behaviour reflects that a lot has changed in the last few years and that now retail investors are acting in a more mature manner, displaying discipline while taking investment decisions.
Once again when the market has taken off on an upward spiral and has risen by more than 40 per cent from its recent lows, investors have started to book profit. This has been reflected in the June 2020 mutual fund inflow numbers where redemptions have increased considerably from equity-dedicated funds. Making these tactical investment moves should be part of your entire investment strategy but this should not be your only investment strategy or rather a trading strategy. Nobody has ever consistently timed the market and benefited out of it. To fulfil your long-term investment needs you need to have a more disciplined approach.
The investment decision process for retail investors is well cut out and has been documented by professionals and academia. There is a five-step process that needs to be followed in a sequence.
1. Setting the long-term asset allocations, as for example, how much of your investment should go into bonds and how much should go into stock.
2. Establishing the investment policy and rebalancing the parameters.
3. Determining the active and passive allocations of your investment.
4. Selecting the funds based on the above decisions.
5. Continuous monitoring and rebalancing of your portfolio.
The activities listed above should be followed as per the given sequence and the decision on the first two points forms the core of your investment process. There are many research papers that indicate how the first two activities will account for most of your portfolio’s long-term returns. One of such prominent studies is that by Gary P, Brinson L, Randolph Hood and Gilbert Beebower, published in 1986, which reported that an investment policy – measured as the average quarterly exposure to stocks, bonds and cash – explained 93.6 per cent of the variation of quarterly portfolio returns, whereas on an average, the market timing explained only 1.7 per cent of the variation in portfolio returns and reduced portfolio performance by 0.66 per cent per annum.
Despite this, many individual investors guided by their advisors blindly follow the traditional multi–asset class, multi-style model to construct their portfolio. They will invest in different sub-category of equity and debt to diversify the portfolio. This is a process that is being mostly followed by institutional investors. However, this may not suit retail investors. So, what is it that retail investors should follow? They should follow a core and satellite strategy to design their portfolio. This means a portfolio with a core of long-term holdings orbited by riskier equities such as sectoral funds. This approach reduces the risk of underperforming against adopting an approach where you try to time the market or fill your portfolio with sectoral calls. Besides, it also helps explores more potential to beat the market versus an all-core approach.
Funds to Buy and Hold
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July 20, 2020