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Avoid emotion when investing in equity

Source : BUSINESS_STANDARD
Last Updated: Sat, Jan 05, 2013 18:41 hrs
INDIAN STOCK BROKERS WATCH THE KEY SENSEX SHARE INDEX IN BOMBAY.

The stock markets surprised a lot of investors by rising more than 20 per cent over the last 6 months with the Sensex and the Nifty crossing the psychological mark of 19,000 and 6,000 respectively. During this period when the markets were moving up, a lot of investors who had invested in direct equity or equity mutual funds in the last few years deemed fit to redeem their investments as they were fed up with the inconsistency of the stock market movements and low returns. This trend of redemptions is expected to continue for a while as most investors feel that there are better options and may seek refuge in fixed deposits, gold or even property in some cases. This trend is not new to our markets and we don't seem to have learnt anything from the past.

In spite of knowing the fact that equity investments are meant for long term which is defined as anything more than 5 -7 years, why do these investors behave differently during trying times? Either they are being emotional rather than rational. This makes them ignore the advice of even the market veterans and financial advisors to stay put.

On most occasions, emotion can make us ignore logic and take decisions which might prove to be very harmful to our investments. Though it is a tough task to keep emotions away from investing, a few tips can help you go a long way in your quest for long term wealth creation.

TIPS FOR STOCKS
  • Volatility may lead to negative returns over certain periods
  • Daily market update may not lead to significant improvement in portfolio
  • Regular rebalancing will reduce risk to portfolio

Follow the asset allocation approach: Based on your financial goals spread over various time horizons and your risk profile, allocate your investments into assets according to your time horizons. For example, if you want to plan for your daughter's marriage or your own retirement which may be nearly 10 – 15 years away, then a major allocation of your investments for these goals should be in equity. Those who have time to do research and the skill to identify stocks can invest in direct equity and equity mutual funds, while others can take the help of their advisor / planner and establish their asset allocation.

Understand the volatility factor in equities: Before venturing into equities or equity mutual funds, one needs to understand the volatility factor associated with equities. This volatility may even lead to negative returns over certain periods of investment. One can easily get data on past market trends to get an idea of the duration of the negative periods so you are mentally prepared to face any such adverse periods in your investment cycle. The past data will show that just as the economy goes through various market cycles, its situation gets reflected in the stock markets. Therefore, during a slowdown or recessionary times the stock markets may not do well. These are times when the investments should continue so that you buy at lower levels. This gets translated into better returns once markets rise following the improvement in the economy.

Avoid too much information on markets: We live in the information age today and are constantly inundated with too much information on world markets, politics, research reports etc. The more you try to read to all the information available you get into a situation where you feel that you will be able to identify the problems beforehand and take corrective steps.

This leads to speculation and encourages one to time the markets which have been proved to be futile time and again. A daily market update can be time consuming and may not lead to any significant improvement in your portfolio; in fact it may make you more prone to emotional behavior.

Regularly review your portfolio: One needs to set the frequency for reviewing the investment portfolio. A quarterly update can be good enough. If the asset allocation has changed drastically during the course of one year, then it's advisable to rebalance the portfolio. Rebalancing means shifting funds from the asset which has performed better and where the asset allocation percentage has exceeded the set limit and moving the excess (profits) to the asset where the allocation has reduced.

Sometimes asset prices reach astronomical levels and trade at very high valuations, which increases the chances of a huge correction in prices in the near term. Regular rebalancing will ensure that the risk to your portfolio is reduced. Rebalancing frequently on minor change in the asset allocation is also not suggested as it will invite short term capital gains tax and may negate any short term benefits.

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