By Vinay Ahuja
When you throw a stone in a shallow lake, you can bring about huge ripples and disturb its peace and tranquillity. However, when you throw a stone in a deep lake, you bring about just a couple of ripples and barely disturb it. External shocks, like the COVID-19 pandemic and its consequent effect on financial activity, are stones that can bring about ripples in your portfolio. They engender uncertainty and can lead to intense industry volatility. In the backdrop of such an atmosphere, there will inevitably be ripples in your portfolio. However, the effect and extent of these ripples will be dictated by the depth and resilience of your portfolio.
Financial investments involve an element of danger. These dangers have a tendency to introduce uncertainty in portfolio values and effect return expectations. This tends to make it crucial to construct resilient portfolios that can ably navigate the altering investment climate and climate external shocks. As an investor, you can realize this by identifying the accurate drivers of danger and return, whilst staying focused on your extended-term objectives. To construct resilient portfolios, you ought to be:
-Risk-conscious: Risk is ubiquitous and can present itself in unexpected approaches. The ongoing COVID-19 pandemic is testament to the truth that danger usually catches us unawares. Thankfully, danger can be measured and mitigated. The initial step is to be conscious of prospective sources of danger. Understand asset class danger and apprise your self of the triggers that can raise uncertainty. The next step is to assess your personal danger profile, which will reflect your willingness and capability to absorb danger. Risk mitigation is only achievable when your investments are nicely-aligned with your danger profile.
-Diversification by way of astute asset allocation: This is in all probability the very best way by which you can mitigate portfolio danger and construct a resilient portfolio that can climate industry volatility more than the extended-term. Diversification entails spreading your investments across several asset classes such that sharp movements in any one asset class do not have a disproportionately huge effect on the general danger-adjusted returns of the portfolio. Every asset class has a special danger-return profile and responds differently to the similar set of triggers. As a outcome, whilst particular events may lead to a sell-off in one asset class, they might have small or even the opposite effect on a different asset class. In economic jargon, this indicates that various asset classes can have small or even adverse correlation with each and every other. To realize optimal diversification, you can adopt the asset allocation strategy. As per this strategy, you need to have to initial identify your danger profile, return needs, and investment time horizon. Based on these components, you can allocate your investments across several asset classes such that the general danger and return prospective is nicely-aligned with your special danger-return needs.
-Agile: If your investment tactic remains fixed even whilst the investment atmosphere and your requirements are altering, then there is a possibility of breakdown. Due to the shifting nature of the investment landscape, it is significant for you to be versatile sufficient to respond to altering imperatives and capture industry possibilities. This indicates that you ought to be in a position to lessen exposure when markets are highly-priced, as defined by the P/E ratio and other valuation metrics, and raise exposure when the markets are low-cost.
-Consistent and disciplined: Overall, you need to have to be disciplined and adhere to a constant strategy to portfolio constructing. Avoid obtaining swayed by industry feelings or straying away from your asset allocation tactic.
Portfolio resilience is not basically about constructing a defensive tactic to combat existing industry volatility. A really resilient portfolio will not only assistance you proficiently mitigate quick-term shocks, it will also make sure that you are in a position to navigate extended term-trends to optimize danger-adjusted returns across industry cycles.
(Vinay Ahuja is the Executive Director of IIIFL Wealth Management. Views expressed are the author’s personal. Please seek the advice of your economic advisor just before investing.)