Similarly a gymnast on balancing beam walks with both hands stretched in opposite direction, trying to adjust his/her weight in a manner so as to ensure that s/he does not fall. S/he continuously keeps adjusting his/her balance. If s/he walks with both his/her hands only on one side, in all probability s/he will fall off the beam.
If your portfolio is skewed to single asset class, it may fall - when you genuinely need that wealth.
Align investments to your, not market, needs
Imagine if your entire portfolio is in equity and stock market crashes. Your entire wealth will erode. Similarly, if all you have is debt products then movement on interest rates will affect your entire portfolio. This simple looking concept sometime gets ignored.
Recently while addressing a seminar, someone from audience tried discussing her portfolio. She had investment in FD, RBI bonds, PPF, Endowment policies and debt mutual funds. A close look at it will tell you that entire portfolio was in single asset class called debt.
Similarly when equity markets rise, it is very common to see individuals having investments in equity mutual funds, direct equities, ULIP of equity and also placing funds with portfolio manager to invest in equity.
For our portfolio to be balanced, investments have to be made in asset classes, which have movement in opposite directions. In statistics there is a measure called correlation. In simple terms it tries to explain movement of two or more elements.
If correlation is +1 between two elements than it means that if one moves up, second also moves up in the same manner and to the same extend. If correlation between two mutual fund schemes is +1 then when NAV of one scheme goes up by 10 per cent, NAV of second will also go up by 10 per cent.
MF is your personal portfolio manager. Trust it
If correlation is -1 then when NAV of one fund goes up by 5 per cent, another fund will fall by 5 per cent. If correlation is '0' then movement of one NAV has no impact on other one. '-1' form of correlation is the best possible option.
In reality there can never by +1 or -1 correlation. Resultant correlation will fall somewhere between +1 and -1. We have to try and ensure that our portfolio also has `-`correlation amongst its various investments.
Debt and equity usually has negative correlation to some extent. When debt market gave good returns (year 2001, 2002, and 2003) equity markets performed badly. When equity markets started giving good returns (year 2003, 2004, 2005 and 2006) debt markets gave poor returns.
To balance the weighing scale, weights have to be placed in opposite pan. For gymnast to balance on beam, s/he has to stretch hands in opposite direction. A balance portfolio is one where part of it is giving positive returns and other part is generating opposite returns i.e. negative. If your entire portfolio is currently giving positive returns then at some point in time it may happen that entire portfolio will give negative return. Try and balance your portfolio to meet your needs.
The author is a Certified Financial Planner. He may be reached at gmashruwala@gmail.com
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