How a Sound Investment Strategy Can Help You Mitigate the Impact of Market Volatility

June 5, 2023 Mutual Fund

Macroeconomic uncertainty, high interest rate, currency concerns, recessionary risk, etc., are among the key challenges in India currently. These are the factors that may influence the market performance, causing volatility and may have a negative impact on one’s investment portfolio. On the contrary, the Indian equities markets and investors have been encouraged by the relatively improved underlying fundamentals, such as India’s GDP growth, which remained strong during the fourth quarter of FY 2022-23, the expected slowdown in inflation, lower unemployment rate, higher tax revenues, etc.

According to the Year-to-date (YTD) data, India’s two most prominent market indices, S&P BSE Sensex and Nifty 50, have been soaring close to its all-time high of December 2022. The S&P BSE Sensex closed at 62,622.24 and Nifty 50 closed at 18,534.40 as on May 31, 2023. Having said that, investors may be oozing with confidence and remain still very bullish; however, it would be wise to follow a tactical approach and be thoughtful when investing money in market-linked products like mutual funds or direct equities.

Graph: YTD performance of market indices

Do note past performance is not indicative of future returns.
Data as on June 02, 2023
PersonalFN Research
(Source: ACE MF) 

You see, depending on the investor’s mindset and approach, market volatility may make or break their investment portfolio. Investors should not panic during tumultuous times; instead, they should be ready with their investment plans. Unexpected market changes can be weathered with the aid of a well-diversified investment plan. Some investors would attempt to time the market in an effort to profit from such a forecast, but it is incredibly challenging to predict the timing of a market downturn with accuracy. In other words, making a mistake with such a prediction is simple, which might cost investors’ money. To feel in control and unaffected by how the market performs in the near term, investors must thus have a tactical investing plan in place.

Experts anticipate that the market in 2023 will be just as volatile as it was in 2022. In this volatile market, focusing on the following investing strategies will not only endeavour to generate optimal gains but also enable much-needed stability to your portfolio.

1. Don’t abandon your investment plan

Create an investing strategy based on your risk tolerance, time horizon, and S.M.A.R.T. financial goals. Once you have a well-diversified strategy with the appropriate asset mix, you may periodically review it and update it in light of new life events and goals. Remembering your objectives and plan of action can help you stick to your strategy and prevent making investment decisions based on market swings or your behavioural biases when there is market volatility.

[Read: Avoid these Investing Mistakes to Protect Your Portfolio in a Volatile Market]

A sudden drop in the market can have dramatically different implications for someone just starting their career compared to someone nearing retirement. What’s important is you understand your situation, market conditions and stick to your investment plan. Often, investors stop contributing towards their long-term mutual fund SIPs or pause investing until the market corrects, when they witness a slump in the indices. Keep in mind that one may overcome losses if one sticks to their investment strategy and does not panic; future gains may compensate today’s losses.

2. Diversification is the key

A well-diversified portfolio containing a broad mix of asset classes like equity, debt and gold will likely be less volatile over the long term than a portfolio concentrated in only equity or debt investments. In an all-weather portfolio, losses in one asset class tend to be offset by gains in other areas. So if you want to mitigate the level of volatility in your portfolio, diversification is the key.

It’s also important to choose an asset allocation that makes sense for your financial situation and aligns with your goals. Broadly a 12:20:80 asset allocation rule may be followed. With this strategy investors could allocate at least 12 months worth expenses in liquid funds for times of emergencies, 20% of their entire portfolio in gold to give downside protection during times of uncertainty, and invest 80% of the portfolio in diversified equity funds.

Simply put, gold is regarded as a safe haven and an excellent portfolio diversifier. Additionally, many successful investors use the ‘Core & Satellite’ technique when investing in equities. ‘Core’ refers to the portfolio’s more stable, long-term equity holdings. ‘Satellite’ refers to the strategic component that would support boosting the portfolio’s overall returns regardless of market conditions. Investors may consider less volatile asset class known as debt in order to offer stability to the portfolio. Now that the interest rates are at peak, investors could look into longer duration funds. For short-term one may consider allocation to liquid funds.

However, when you are entirely or substantially invested in one theme or sector, you face the risk of concentration. If something goes wrong with the sector, your entire portfolio may go for a toss. The answer to concentration risk is also diversification. For an investor, one of the easiest ways to diversify all of these asset classes is through a multi-asset fund. A SEBI registered investment advisor can help you diversify your investment and choose assets that reflect your suitability.

3. Stay put through high tides

Volatility in the market is a sign of a vibrant and prevalent market, and dramatic moves in the market can make you question your portfolio holdings. However, the historical evidence demonstrates that when the market appears tumultuous, it eventually recovers even stronger. Focusing on your long-term investment objectives can help you block out market noise, avoid adopting the herd mentality, and keep from making decisions that are inconsistent with your investment approach.

Short-term losses can trigger anxiety, but letting emotions drive your investment decisions may prove costly. One method to manage market volatility is focusing on long-term outcomes rather than short-term setbacks. The truth is that volatility cannot be avoided, regardless of whether your investments are in bonds or equities. The good news is that by adopting a long-term and diligent strategy, volatility may possibly be managed. Volatility hits you hard when you play the market as a short-term trader. From a long-term standpoint, volatility in equities tends to even out over time.

4. Rebalance your portfolio if required

Volatility provides an ideal opportunity to review and perhaps revise your asset mix.

Investors may think about rebalancing their portfolio if necessary due to a change in their financial situation or to eliminate any consistent underperformer from the existing holdings in their portfolio. An investor’s anxiety is increased by the swings in portfolio value amid erratic market conditions as well as the influx of unfavourable market noise. Always keep in mind that snap selections based on current market trends may cost you a huge price.

When your portfolio is shrinking, it’s preferable not to think about new strategies. Instead, perform a portfolio review and analyse your assets using a variety of quantitative and qualitative parameters. If necessary, one may rebalance the portfolio in case the current asset allocation needs any further fresh investment or shifting.

5. Hedge the portfolio against risk

Some risk is involved when investing in any asset type, whether equities or debt. Although many people would argue that risk is merely volatility, there is really little distinction. Volatility is not risk; it is the manifestation of risk. Hence, a risk to investors in the context of the financial markets refers to the likelihood that they may sustain losses as a result of variables affecting the overall performance of the markets in which they are engaged.

One can meaningfully aim to balance risk and returns based on one’s risk appetite. The first step in managing investment risk is understanding your risk tolerance. Understanding your risk tolerance is the first step towards managing investment risk. Your desire to take risks and your capacity to do so together define your risk tolerance. Your psychological makeup and preferences, and financial situation all have an impact on how risk-tolerant you are.

Additionally, the risk/reward profile of your portfolio is determined by your asset allocation, which you may tune by establishing target ratios for various asset classes. To avoid any unforeseen losses, make sure your investment portfolio is in accordance with your risk tolerance.

This article first appeared on PersonalFN here