More debt will cool down your portfolio

When equities are making money, it is a tough call to book profits

Equity investing is exciting, especially when the stock markets are on a roll. And, it is a rather difficult task to sell stocks or equity mutual funds (MFs) when these are rising consistently.
 
Rajesh Chand, a Kolkata-based businessman, recalls his close call in the stock market. In January 2006, when Aban Offshore was trading at around Rs 580 per share, his father gifted him 200 shares of the company. The stock was on fire and continued rising for the next two years, and hit Rs 5,000 in two years. Chand’s father started tell him to exit when the stock price hit Rs 4,000 per share. As he candidly admits now, he was simply unable to let go. Then, the crash came.
 
“I would go to the sub-broker’s office and pray that I get a good exit price,” he says. Finally, he was able to sell it at around Rs 2,000 per share in August 2008. “For years, my father would remind me that because of my greed, I had lost Rs 2,000 per share (Rs 4 lakh in total).” The lesson: Making money in the stock market isn’t easy. But, losing it doesn’t take much time.
 
The need to rebalance: Financial planners keep harping on the need to rebalance your portfolio when you are sitting on good profits from any particular asset class, such as equity or debt. Benjamin Graham, popularly known as the father of value investing, has advised that investors use a 50:50 stock/bond allocation, and depending on market conditions, shift as far as 25 percentage points in either direction.
 
Says Suresh Sadagopan, founder, Ladder7 Financial Advisories: “In today’s heated market conditions, rebalancing your portfolio to 25 per cent in equity and increasing the debt portion to 75 per cent seems to be a good strategy. When equities are reasonably priced, one can put a maximum of 75 per cent of overall portfolio value into it and 25 per cent should always be maintained in debt. With this basic thumb rule, one can navigate through uncertain times in financial markets.”   
 
Of course, a number of other factors also come into play here. For example: Your age, goals, risk appetite and so on. Says Hemant Rustagi, chief executive officer, WiseInvest Advisors: “Even rebalancing requires a particular strategy. For example, if you have two years to go for a particular goal, there is definitely a need to move money from riskier assets to low-risk assets.”
 
However, he suggests there be a clear strategy, even for investors following asset allocation. If the debt or equity portion has risen more than 10 per cent, it might be a good idea to rebalance. “For those who have 10-15 years to retire and do not need the money immediately, there is no urgent need to diversify the portfolio currently. Even if the market falls, there will be opportunities to buy stocks and for regular investors investing through systematic investment plans, it is good news because it will give them more units of their schemes,” adds Rustagi.  
 
With the BSE Sensex rising over 15 per cent in the past six months, there has definitely been some spike in investors’ portfolios. At the same time, returns on debt instruments have been declining due to a fall in fixed deposit rates to around 6-6.5 per cent. For ones looking to diversify, there are many options.
 
Equity-oriented hybrid funds (balanced funds): Essentially, these are heavy on equities (minimum 65 per cent). At the same time, they maintain a good debt allocation of maximum 35 per cent. The advantage: Due to high equity allocation, they are taxed like equities: 15 per cent capital gains tax if the fund is sold before one year and nil if held for over a year.
 
Equity arbitrage funds: These funds invest in equity arbitrage opportunities present in different indices or in the cash and futures market. This results in very low risk and thereby low, but safe returns (generally six-seven per cent a year). However, it is taxed like equity funds and helps in navigating through overpriced markets.
 
Short-term debt funds: A conservative option in which fund managers invest in short-term papers with maturity of less than three years.
 
Income funds: These funds invest in corporate bonds, government bonds and money market instruments. Depending on the portfolio, they can be further categorised as accrual strategy, duration play or credit play. Investing in accrual strategy income funds with highly rated papers (generally AAA+) with lower government security or gilt exposure will help in mitigating any volatility in debt market during change in the interest rate cycle.  
 
Monthly income plans: This is a debt-oriented fund with a small exposure to equities (typically between 5-25 per cent). This would be a low-risk strategy where capital would be preserved, with the growth kicker coming from the equity component.
 
While there is no single silver bullet solution for all investors, a broad outline of how to go about reinvesting the profits from equities has been given in the table. However, remember that financial planning for each person will be different.