The Sensex has been flirting with the psychological level of 50,000 for some time now and has been quite volatile in recent weeks. Even though 50,000 is just a number, the fact that markets are up almost 100 percent since the March 2020 lockdown lows is remarkable because of the ferocity of the recovery.
So what should investors do now, as markets continue to flirt with fresh all-time highs and have doubled in a matter of months?
Should they sell, stay invested or put in fresh money?
Staying on in rallying markets
To be fair, nobody wants to leave the party when it’s on. Markets have been rising like there is no tomorrow. Making money from stocks seems easy these days. So why would anyone want to stop now?
But that is what sensible long-term investors might do. It’s not easy to take a step back and review what is happening. But that is the right thing to do. Smart investors will never be swayed by the returns of the recent past alone.
So what should be done?
Let’s go through a small hypothetical scenario (which is based on some actual data) to understand this better.
Suppose around the March 2020 lows, you had a portfolio of 60 percent equity and 40 percent debt. Now, from the lows (Sensex @ 25981), the markets were up almost 100 percent in mid-February (with Sensex @ 52154). So assuming the debt instrument delivered about 6 percent annual returns, the current asset allocation would be close to 74 percent equity and 26 percent debt.
This is a far cry from what was originally intended. And this means the investor who started with 60:40 allocation now holds a very different portfolio mix. A rebalancing exercise will restore the original asset allocation. That will in turn help reduce the risk in the portfolio by protecting the downside in case there is any short-term market correction in near future.
Rebalancing portfolio periodically
Generally, investors should rebalance their portfolios at least once a year. But with the markets delivering great returns in the recent past, it might be a good time now to rebalance your portfolios once again to bring in a sanity check. Rebalanced portfolios are known to deliver better risk-adjusted optimal returns in the long run.
There is another angle to this discussion. A portfolio’s asset allocation should be chosen based on the type of the goal being pursued. So, investments should be goal-driven and asset allocation should be chosen accordingly. All goals are not alike. So you can’t invest in the same manner for all the goals.
If your goal was short-term in nature, with a small equity component, then the recent run-up gives you a good opportunity to lock into the profits and reduce the equity component of your short-term portfolio even further. On the other hand, for your long-term goals, the run-up would have skewed your portfolio towards equity and may have rendered it unbalanced (i.e. portfolios aren’t unnecessarily overweight in any specific asset class) and exposed to unnecessary risk. So, you can do a rebalancing exercise to bring the portfolio back on track.
When rebalancing, you should also weed out the non-performers from your portfolio. Rallies such as these, where everything is going up, give the rare opportunity to get out of laggards of the portfolio at good prices.
If you have fresh money to invest but your time horizon is short (less than three years), then it’s best to avoid equities. Or, keep equity limited to a very small percentage of your portfolio if you really do need to dabble in it.
When the going is good, many investors get bogged down emotionally and try to wait ‘a bit longer’ to maximize their profits. But such an approach may not work and in the worst case, may backfire as well. If you are finding it hard to review your portfolio and rebalance it, then take help from an investment advisor who can look at your portfolio from an unemotional and unbiased perspective.
Remember that Sensex crossing 50,000 may just be a statistic. But the equity allocation of your portfolio would have drifted away from the initial allocation Don’t try to be the last person to leave the party in the stock market. Take corrective action (rebalance) as soon as possible.