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Sanjay Shukla,(29) has been investing in Systematic Investment Plans, (SIPs) in diversified equity funds for the last three years. Of late, his patience seems to have run out after seeing his equity portfolio in the red for quite some time now. He is thinking of stopping his SIPs as he believes that the equity markets will fall more in the coming days, which will further reduce his portfolio value.
K R Rao (45) had invested a lumpsum amount in a gold savings plan few months ago and is now ruing his decision as that fund has fallen by nearly 10 per cent reflecting the correction in gold prices. With indications that gold prices will fall in the days to come, Rao is considering redeeming his investments.
Many investors like Shukla and Rao invest in assets like equity or gold without understanding the behaviour of that asset.
Unlike fixed deposits and postal savings, the returns on equity, gold or real estate are not assured, which makes them vulnerable to price volatility in the short term. Each asset class is different and so is its behaviour during different situations.
Equity
An understanding of the past performance of equity markets or equity diversified funds can give an indication of the volatility that's associated with equity.
Warren Buffet has famously said that "Only buy something that you'd be perfectly happy to hold if the market shuts down for ten years". This gives an indication of the long periods of uncertainty that can affect equity markets, but only those who stay put with their investments are suitably rewarded.
So if you do not have the risk appetite nor want to see any risk associated with your investments, then equity investments are not for you.
Secondly, invest in equity only if your goals are of fairly long term and after having understood that you may see long periods of negative return, especially in times such as the one that we are currently going through.
Real Estate
We have seen real estate prices go through the roof in the last 10 years. Many have forgotten the decade before 2003, when the real estate asset prices had collapsed, those who invested at the peak in the 1990's lost out big time when they sold at a discount. Real estate as an asset class is good, but again, only if the investment is done as a long term asset associated with your goal.
Gold
Gold has had a dream run for several years now. Many investors who invested in gold as an asset class a few years back have gained handsomely. But at present gold prices have been correcting for the last few months.
Therefore, one needs to understand that even gold prices are volatile and, hence, investing in a staggered manner can be beneficial if gold has been suggested as a part of your portfolio.
Debt funds
This category offers a huge variety of funds to choose from depending on the time horizon. Most of us are at- least aware, that equity funds can give negative returns during certain periods. But not many know that there are certain debt funds which display a cyclical pattern in terms of returns and are very sensitive to interest rate changes.
Most gilt funds and some income funds typically invest predominantly in government bonds which are vulnerable to interest rate changes. Going ahead, the interest rate is showing a declining trend which bodes well for gilt funds. When interest rates decline, prices of government bonds will rise resulting in higher Net Asset Value for the funds which in turn results in higher returns. A reverse situation can pan out during the interest rate cycle going up, which can result in lower or negative returns in gilt funds.
The intention of a well diversified portfolio is to reduce risk and allocate assets as per your goals and time horizon. Secondly diversified portfolio is relevant because during different time periods, there could be one asset class which will perform better than the other.
Therefore, understanding each asset class before making it part of your portfolio is important in order to avoid any knee jerk reactions at extreme situations which might nullify the entire objective of building the diversified portfolio.
REMEMBER
- Equity investments can go through long periods of negative returns
- When interest rates go up, returns from debt funds can decline
- Real estate investment must be for long term
- Make gold investments in a staggered manner since prices can be volatile
The writer is Chief Planner, Proficient Financial Planners
