Markets at new highs and overvalued: Here’s what equity fund investors must do

If the stock markets are looking jittery, it is not without reason. The Nifty is trading at a PE of 27 times, against its 10-year average of 20 times, while the market-cap to GDP ratio has touched 105, against a historical average of 79. There are other negatives, too. Global crude prices are up, the rupee has fallen sharply against the dollar in the past one month and inflation is on the rise. Besides, the COVID-induced uncertainties and the impact of the lockdowns after the second wave will show up in the first quarter numbers announced this month. The markets certainly look expensive and, perhaps, appear ripe for a correction.

What should mutual fund investors do in this situation? They have earned good returns in the past 8-10 years, thanks to one of the longest bull runs in recent history. But if markets recede, those returns may get eroded to some extent. Even so, exiting is not an option they should consider without first assessing their goals and requirements. The decision should be guided by the time horizon of their financial goals.

Long-term goals more than 10 years away

If your financial goals are more than 10 years away, there is just no reason to feel worried. If you look at the trajectory of the Sensex in the past 10-15 years, you will see many ups and down, but the long-term trend will remain upwards. Yes, the portfolio would witness volatility in the coming years, but that is the inherent nature of the equity asset class. Continue your SIPs in a disciplined manner and don’t let the market noise distract you from your goal.

As a long-term investor, you should welcome a decline in the markets. It is an opportunity to accumulate more units at lower prices. In fact, when markets tumble, you should direct more towards your equity funds to gain from the decline in stock prices. Keep in mind that when the market crashed in March 2020, investors who stayed put or added more made truckloads of money.

Medium-term goals that are 4-5 years away

However, if your goals are just 4-5 years away, you might need to make some changes to your portfolio. First, you need to assess your portfolio in terms of market capitalisation. Mid-cap and small-cap funds have done very well in the past few years, but these are generally more volatile than large-cap funds. If you hold mid-cap and small-cap funds, this may be a good time to book profits and switch to more stable large-cap schemes.

As your goals are just 4-5 years away, you need to also gradually reduce your exposure to equities and shift to debt. For this, you can start systematic transfer plans from equity funds to debt schemes. Such transfers should be designed to ensure that 10-12 months before the goal date, you switch the entire corpus to the safety of debt.

Also read: Is it time for investors to take profits off small-cap funds?

Short-term goals that are 2-3 years away   

Whether there is a possibility of a correction or not, investments meant for short-term goals should not be in equities. If your financial goals are just 2-3 years away, you should invest in debt funds where the risk of losing money is far lower. Even if you take the SIP route, don’t invest in equity funds unless you can commit to a five-year investment horizon. That is the minimum time you should give to equities to earn decent returns. This is especially true of the current situation when markets are at their all-time high levels.

In the long term, short-term declines in stock prices become insignificant, as the broader uptrend irons out the volatility. But in the short term, a steep decline can have a deep impact on the investor. It is therefore advisable to shift the investments meant for short-term goals from equity funds to debt schemes immediately. The returns of debt funds are not as spectacular as those of equity schemes, but they are also not volatile. You will not make big money but will also not lose money. The stock markets may remain flat or even dip in the coming months, which could lead to a shortfall in your targeted corpus.