Shock proof your portfolio

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While most of us were spending sleepless nights mulling over the world wide slide in equity markets, and the deep gash its left on our portfolios, a few smart investors have been going about their life as usual. They take comfort in the fact that their investment portfolio is adequately insulated; that the greatest determinant of their portfolios return is the asset mix in their portfolio, which has helped reduce the ill effects of volatility.

Invest in equities preferably for long term: Today if you were in a position to stay invested for 20 years or more, you should not be looking at any other asset class other than equity, it has clearly out-performed all other asset classes (other that real estate in select areas). But most of us are not tuned to investing with such a long time frame clearly mapped out in front of us. While all of us have goals which are long term we invest with a short term mind set.

There is a theory which shows that most of us sell our profits very fast and hold on to our losses for long. It's in fact so ironical that equities which should be invested into only with a long term horizon, is the one asset class most people tend to move in and out off the most. Most of us are in the habit of continuously monitoring our portfolio on a daily basis, some of us have got into the nasty habit of looking at it every hour. This kind of obsessed nature has resulted in us taking decisions which are not conducive to our portfolios long term growth.

 Financial Planning and Asset Allocation can help in reducing your portfolios volatility in the short term and more importantly provide some much needed discipline to your investments by providing a basic road map for your savings strategy.

Don't have an asset allocation? You're shooting in the dark: All of us spend a huge amount of time, researching on our own as well as on tips, deciding which stocks to buy and which to sell and whether its time now to get into debt. While all of these are genuine concerns which investors must face, your success as an investor as well as your achieving your long term financial goals is deeply entrenched in your asset allocation decision which is more or less stable in the long term.

We have heard of the adage, advising us not to keep all our eggs in one basket. Most of us believe that we are firm followers of this policy, but nothing could be further from the truth. While I agree that we all have some kind of asset allocation in place, how many amongst us have actually planned what asset allocation suits him/her the most. Most of us have some vague idea of the risk we can tolerate and decide that we should invest an "x" percentage of our total assets in equities or fixed income assets.

The balance follows through from this decision. What we do not realize is that, no matter what our attitude to risk, we are saving towards certain goals, and to make sure that we achieve those goals, we have to either stretch ourselves and save more or make our money work harder.

Its easier to change your asset allocation than your level of saving: While most people may start their financial planning with their goals and risk tolerance, which in turn determines their asset allocation strategy, and then go on to decide how much more they have to save, I am of the opinion that most people would find it easier to change their asset allocation (in favor of riskier assets) then they do their level of saving.

Let's move on to how you should go about dividing your assets between different asset classes. Every investor faces the challenge of balancing downside protection (against capital loss) with upside potential (for high returns). People are more sensitive to losses than they are to gains of the same magnitude.

Your need for downside protection is also a function of the length of your investment horizon (how long before you'll need the money) and whether or not you are making regular withdrawals from your savings (as would be the case, for example, if you were gradually drawing down your savings to pay your bills during retirement). The shorter the time before you need the money, and the more you're planning on taking out along the way, the more downside protection you need. 

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