Earlier this week, we spoke about the Principles of asset allocation and risk apettite in a short question and answer post on our Facebook page. In this blog, we look at this principle in greater detail and more practical aspects of it.
When going is good we like to travel and keep going. But when the ride becomes bumpy, we start questioning our path. We start having second thoughts. This is something very true with Equity investing.
Last year, at this time of the year, many portfolios were running with high double digit growth. The feeling was, like, why invest in debt fund, we should be more in equity, it’s time to make the most of the India growth story, and the like. Things are not the same today.
Today, after slide in market for 1-2 months, the attitude that has come to the forefront is that of being Risk Averse. Suddenly, there is talk of real estate, stable avenues etc. So Risk off is on.
The mind seeks stability. This is true. But historically it is proven that the bad times are the right time to invest. For e.g. After 2008 crash- 2009 was good time to invest, to gain on subsequent rally in 2010-11.
Logic and theory says that we should visit asset allocation periodically. To adjust asset allocation means to rebalance the portfolio by buying the securities that have lost in value to adjust proportion of pre decided of asset mix and to strengthen the portfolio by making small tweaks.
In today’s times equity values have fallen. We mentioned to one of client, it could be good time to put more in equity. This advice is logically correct, but emotionally it may be challenging to go with. After all, who will want to put more in leaky bucket?
We are human beings, emotions guide our decisions. Recency bias is very strong in investors – in which recent events influence our decisions more than fundamental thinking. If you experience notional gain in investment you feel like investing more. If you experience investment depletion on paper, you carry negative experience and results in no decision or withdrawal.
Harry Markowitz wrote Modern Portfolio theory. He was awarded Nobel Prize for his work. Markowitz stated that risk reduces if you invest in a group of stocks/assets and investor can select the best combination to maximize the gain at given level of risk. He named this approach Efficient Frontier.
Without Going to much technical, the incident we want to mention to buttress the point of this blog is in this short conversation.
Harry Markowitz been asked Where have you invested your prize money?
He answered, “I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.”
What we see here is that the man who wrote famous theory on how to construct the strongest possible portfolio was incapable of applying his breakthrough theory to his own money!
This is not strange. It’s being quite natural and human. In these kinds of market period our role as an advisor becomes critical in order to keep you on the right path of investing and guide you on the path to achieving your long term goals.