“Do Nothing” is the straightforward reply to this question. In a perfect environment, if stock prices are at an all-time high, plummeting, or gliding sideways without making sense, you just ‘ignore’ these moves.
You’re an investor in mutual funds, not an equities trader. You pay the fund company a sizable sum of money in costs specifically for money management. What is the fund manager doing if you have to worry about what the markets are doing and how to alter your investments accordingly? The main benefit of investing in mutual funds is that you don’t have to worry about the stock markets.
The world we live in is not perfect. It’s practically perfect, at least in terms of mutual fund investments, if you choose carefully, keep an eye on your investments, and make any adjustments.
How can we value the market?
Analysing some valuation measures, such as the Nifty’s price to earnings (P/E), price to book (P/B), and dividend yield, is the standard method of responding to this question. We may examine these valuation ratios’ present values and compare them with their median values over the last ten years. These are fundamental hints of value. Valuations can be seen in a variety of ways, and they may all be pointing in opposite directions simultaneously.
However, valuation is a complex subject. The investor only determines if a valuation is expensive or not. Depending on what one is looking at, the market may appear pricey to one investor yet appealing to another. For instance, based on market conditions, balanced-advantage funds are allowed to change their equity-debt mix. When markets are costly, they seek to minimize their exposure to equities, and vice versa. This implies that there isn’t a single, universal method for determining stock values.
Future earnings potential determines valuations. Therefore, high valuations can also indicate optimism about a company’s future.
Additionally, broad-based valuation figures may be deceptive. The values of the fundamental components determine market valuations. The Sensex, for example, consists of thirty equities. Its total values are a weighted average of the 30 stocks’ individual valuations. Of course, not every stock would be pricey. Not all would be cheap. For this reason, experienced stock investors sometimes overlook market valuations and search for bargains in the larger selection of equities across several markets.
What edge do mutual fund investors have:
First off, market levels and valuations shouldn’t really worry investors in mutual funds. As a fund investor, your task is to simply concentrate on your objective and continue making investments in order to achieve it. If you have been investing for your child’s college education, retirement, or any other long-term objective, you should disregard the market’s movements and keep up with your Systematic Investment Plans (SIPs) in the mutual funds of your choice.
Keep in mind that you have trusted the fund manager to choose stocks for you as an investor in mutual funds. Therefore, managing the valuation of the portfolio is the responsibility of your fund manager, not you. He would buy or raise his holdings in the bargain stocks and sell or cut his holdings in the expensive ones. If he believes that there aren’t many opportunities at a given moment, he can also decide to add to the amount of cash in the portfolio.
SIP mistakes that you should avoid doing:
When the market rises, a lot of mutual fund investors halt their SIPs or new investments. They believe that waiting for a market decline or lower levels to make investments is a wise move. This proves to be an expensive mistake over time for a number of reasons:
- No one really knows about the markets – Since the markets have been trending upward over the last four years, with only brief periods of pullback, the wisest course of action for an investor would have been to just keep investing.
- When you try to time the market, re-entry becomes almost impossible – Re-entering the market will be challenging if it continues to rise. Even if your timing is right, you might still want to wait because there might be additional corrections coming. Because of this, attempting to timing the market is a definite way to end yourself in a never-ending predicament and confusion.
- If the markets keep rallying and you are sitting on the sidelines, you bear an opportunity cost – Missing out on the finest days usually comes at a heavy cost. According to past data, your whole corpus could be affected if you miss the market’s best days. Markets may be overpriced for a long time even if you are correct about overvaluation. In January 2003, the Sensex stood at about 3,000. Prior to the subprime crisis, it was around 20,000 in December 2007. It appeared pricey at all highs, but it remained that way for a very long time. You would have missed the Sensex’s seven-fold growth if you had remained out of the market throughout this time. Its needless to say where the Sensex is currently.
Nevertheless, resist the urge to take advantage of the market’s surge if you have a financial objective that is due in less than five years. Create a Systematic Withdrawal Plan (SWP) and begin making periodic withdrawals from the market.
Asset allocation is the key:
The most effective weapon against bull and bear runs for a fund investor is asset diversification and regular rebalancing. You should start by deciding on your ideal asset allocation if you haven’t already. The distribution of debt and equity in your portfolio is known as asset allocation.
Gold, silver, and other asset classes may be added to their asset mix by certain investors, but for the majority, dividing the corpus between debt and equities is adequate. The asset types of debt and equity are essentially opposite of each other. Equity can yield higher profits in the long run, but it can also be volatile in the short to medium term. Returns on debt are typically lower to moderate, but they are also less erratic and is steadier. Therefore, the foundation of every asset-allocation strategy is made up of debt and equity.
You may select an asset-allocation mix based on your age, goals, and risk tolerance. The majority of working-age individuals can manage a typical mix of 75% equity and 25% debt. You may decide to make it 50:50 or even 25:75 as you get closer to retirement, but don’t cut down on equity too much because that’s what gives you inflation-adjusted returns in retirement.
Rebalance your portfolio:
You just need to periodically rebalance your portfolio after determining your asset allocation. For example, you can sell 10% of your equity and purchase debt if your target equity-debt ratio is 75:25 and the equity portion has increased to 85% as a result of the bull run. As an alternative, you might shift your additional investment flows to debt in order to restore the intended asset allocation. When this is done well, profit booking in overpriced markets is resolved. You would do the exact opposite in a bear market. That would allow you to purchase more equity at a discount.
Selling a portion of the overpriced asset to rebalance may also result in some capital gains tax. In order to prevent it, you can first restore the asset allocation using incremental investment flows, as mentioned above (That is, if the market has had a bull run and your equity allocation has increased to 85%, then add all your new investment in debt till the asset-allocation mix of 75:25 is reached).
Second, don’t change the allocation until your target levels have been significantly exceeded, such as by 10% or more. Avoid doing it for small variances. In stock markets, a few percentage points here and there are common.
Third, if changing allocations is too much effort for you, use hybrid funds. Hybrid funds have predetermined debt and equity proportions and therefore are exempt from paying taxes on purchases and sales. Therefore, investing in them offers tax benefits in addition to eliminating the need for periodic rebalancing at your end, as these are taken care by the fund company.
