What it means to be cautious in today’s market

Great illustration of Retro styled Businessman running for his dear life to get rid of the gigantic metaphorical bomb.  

Everybody advises you to be cautious in today’s stock market. But what does that mean, exactly? How do you know what needs to be done to reduce your risk? Here’s what investors typically ask us: “Can I stop my SIPs since the market is at a peak?” “Should I switch out of equity and move to debt?” “Can you tell us when the market will peak so that I can exit?”

Our responses to the above 3 questions go like this:

Don’t stop your SIPs. Treat them like your monthly savings. You don’t stop your savings, unless you are unable to save any more.

On exiting: it is never a great idea to exit all equity and sit on cash even in the worst of times, simply because you may encash too early and lose a lifetime’s wealth-building opportunity!

On market forecast: crystal balls are clouded most of the time when it comes to predicting markets. Weather forecasts may be easier. So, ignore it.

What to do

This is the really hard part. Here are some pointers on what you can do to stay cautious in a market that is well above anybody’s comfort zone. These are just broad rules. Your own needs, time frame, asset allocation and risk profile should govern whether you need to de-risk your portfolio at all and if you do have to, then to what extent. If you hold a portfolio of mutual funds, then the simplest way to de-risk your portfolio is through ‘rebalancing.’

Rebalancing is not just reviewing your portfolio, playing the game of ‘good fund/bad fund.’ It is reducing the inflated part of your portfolio and adding more to the deflated part. Inflated from what point? From your original allocation. For example, if you invested 60:40 in equity and debt a year ago (just a simple lump sum) it would be 68:32 now (assuming 5% debt return and Nifty’s return for equity).

No crystal balls needed

This is good enough a deviation for you to put it back to 60:40. This way, you do two things: you are reducing exposure from an inflated asset class based on your portfolio allocation and not based on market. Second, you are booking profits, without the need for any advice from a crystal ball gazer!

Now, this is the top level. Where should you book profits or make exits in your mutual funds? First, exit poor performers. Then reduce or trim in high-risk segments such as mid- and small-cap and sector funds and finally, book some profits even in your best performing funds if their returns are outsized — in that order. But the other important thing is what you do with this money. Rebalancing is not just about booking profit; it is equally about re-deploying it in your portfolio in a different asset class. So, invest them back in existing debt funds or gold. But if you think you will want to set some money aside to invest in a correction, then park some money, say 5-10% of the profits booked, in an arbitrage or liquid fund. Don’t measure returns here. They are meant to be liquid.

While rebalancing can be an annual affair — tied to the calendar or financial year — when markets turn frothy, rebalancing is best tied to your portfolio allocation and deviation.

So, a quarterly check on how much your asset allocation has moved out of sync, will prevent any shocks in frothy markets, as corrections can happen any time.

The above rebalancing need not disturb your running SIPs. You don’t need to change their proportion. You can, when a correction happens, simply invest more in equity — in 2-3 instalments, if you had kept some money in liquid or arbitrage funds.

Now, rebalancing need not be the only way to de-risk your portfolio. If your asset allocation has not moved way away from your original proportion and the market froth bothers you, you can still de-risk your portfolio without moving to cash or debt.

You can reduce mid- or small-cap and move to low-volatile funds or simply large-cap index funds; or reduce your downside with low-risk equity savings funds. Note that these are not substitutes for debt. They are low-risk options within the equity asset class.

Booking profit

While rebalancing works well for a mutual fund portfolio, when it comes to stocks, profit-booking is inevitable. Here, a multi-pronged approach of market-cap based, sector-based and individual stock-based approach is necessary.

Riskier categories such as mid-cap and small-cap deserve profit booking (not selling), when they become multi-baggers. You never go broke by taking profits along the way, even as you continue to hold.

You can use an approach of either taking your capital and retaining profits (especially if your capital was large and the profit is also outsized) or taking profits alone and retaining capital (for solid stocks that you have held for long). Sectors that have rallied a lot also merit attention for pruning or even exiting them (like the end of a commodity cycle). Remember to deploy the cash booked, in short-term fixed deposits or ultra-short debt funds.

And take note, you book profits to ‘preserve’ the money earned. Don’t put them in other risky asset classes like bitcoins. Knowing what to keep and what to exit is no easy decision. But ensure you don’t have a case of the tail wagging the dog.

(The writer is Co-founder,

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Printable version | Jan 29, 2022 7:59:18 AM |

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