Asset Allocation – The key to avoiding sleepless nights in investing

Bulls and Bears – They lead the charge on the exchanges on different days. Actually, why on different days…sometimes the effect of both is visible at different times on the same day. The market is an aggregate of bulls and bears and it reflects the general sentiment.

Is this only true for stocks? The answer is no. This is true for all asset classes. In recent times, commodities (e.g. oil) have shown high volatility. Brent crude in Mar 2021 was around $60, rose to $85 on Oct 21, fell back to $70 on Dec 21, topped $125 recently. It’s just an example.

Do all asset classes move in sync – the answer is again no. Different asset classes are often uncorrelated. For example, on February 24, 2022, when the NSE 50 index fell more than 4.5%, gold posted a gain of 0.8%. So while there may be chaos in one market, the reverse may be true in another market, suggesting that there is always a “bull market” somewhere.

Are the markets easily predictable? The answer to this question is also – No. What if we were told at the start of the year?

a) A month-long war (Russia/Ukraine) will take place,

b) US 10-year benchmark rates will rise from 1.5% to 2.3%,

c) Oil would go from 77 USD to 120 USD,

d) FII would sell more than 1 lakh crore in Q122,

e) The US Fed would increase yields.

Where do you expect NSE 50 to move in this time frame? Obviously, a major price correction and exit from stocks; but NSE 50 was stable at 17,354 on December 31, 2021 and at 17,315 on March 22, 2022. This example illustrates 2 challenges:

  1. Predicting macros is easier said than done to tell in advance what events would unfold.
  2. Even if by luck (or skill) we predict correctly – we still don’t know if the market will go up or down.

Does this mean that investing is just a game of chance? My answer to this question is also a no!! Although it is extremely difficult to predict performance over short periods, asset classes surprisingly tend to give more consistent returns over longer periods. So over time the daily/weekly/monthly/quarterly/semi-annual/annual volatilities continue to decrease to give trend lines.

And if we look at these longer trend lines.

  • Stocks tend to give the best returns over long periods of time (5+ years)
  • Different asset classes shine at different times.

So what can I do to get the best possible returns (comfortably beating inflation) and avoid volatility that will give me sleepless nights? The answer is that I will be in the best performing asset class at all times, this is either an excel sheet exercise or pure fantasy (or luck) over long periods of time. So we need to manage the controllable aspects and invest in a diversified asset allocation (in a mix aligned with our risk profile) and do our due diligence on bottom-up selection (could be stocks/mutual funds or any other product in any asset class). This would ensure that volatility is limited to some extent, and we continue to benefit from asset classes that are doing well at this time. Returns would be much smoother and directionally predictable for longer term investments (say 3+ years). And yes, much less stress – which has a direct benefit that we are likely to invest for longer periods of time to compound our wealth. In short, the golden rule of wealth creation is to invest for the longer term and not worry about short-term ups and downs in any particular asset class!

There is no shortage of uncorrelated asset classes and any primary or Do it Yourself research (or help from an advisor/distributor) would help you get the list. But the key is to understand asset allocation and to understand “uncorrelated asset classes”. and align them with your risk profile. Good investment!

Views are personal: The Author Amitabh Verma, Director at Fission Wealth Private Limited

Warning: The opinions expressed are those of the author and are personal. TAMPL may or may not subscribe to the same. The opinions expressed in this article in no way attempt to predict markets or time them. The opinions expressed are for informational purposes only and do not constitute investment, legal or tax advice. Any action taken by you based on the information contained herein is the sole responsibility of you and Tata Asset Management Pvt. ltd. will in no way be responsible for the consequences of such action on your part.

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