An investor's guide book: The dos and don'ts in brief

Investing is an on-going process that begins with defining your goals and continues through your defined time horizon for each goal. Every investor - new or experienced - has to face numerous challenges during their investment process. 

The challenges usually begin from the stage of deciding asset allocation and continue in the form of disappointing portfolio performance from time-to-time, tackling intermittent volatility, rebalancing to get the asset allocation back on track and realigning it closer to the completion of time horizon. 

While asset allocation determines the potential returns and the attendant risks, the decisions on rebalancing and monitoring the portfolio are crucial from the point of view of keeping it on track.

Remember, the level of investment success depends upon how you handle these challenges. Therefore, make sure your investments remain on track to achieve your investment goals. Don't get distracted and never lose sight of your investment goals. Here's how you can do that.

Don't allow distortions in risk and reward: All investments carry some degree of risk. While the rule of thumb is higher the risk, the higher the potential return, there is no guarantee that higher risk will always get you higher returns. 

In fact, taking unwarranted risk can make it less likely for you to get higher returns. Therefore, understanding the relationship between risk and reward is a key piece in building your personal investment philosophy. Simply put, your asset allocation should reflect your risk profile.

The right way to decide your asset allocation is by aligning it with your time horizon. For example, if you decide to invest in equity funds, you must have risk appetite as well as time horizon required for such an investment. 

Therefore, equity should be the mainstay of your portfolio while investing for long-term goals like building a corpus for children's education and retirement planning. Similarly, while investing for short-term and medium-term goals, debt and hybrid funds should be considered as the focus has to be on the combination of safety of capital as well as earning post-tax returns that are higher than what traditional options offer.

Learn to live with volatility: While the portfolio valuation gets affected by short-term performance of the stock market, it is vital that you don't allow it to influence your long-term investment strategy. For example, a falling market may tempt you to either invest aggressively or abandon an asset class like equity completely. Remember, both these extreme reactions can jeopardize your financial future.

While a disciplined approach is the perfect way to invest in equity for long term, a haphazard approach to realign the portfolio amidst short-term volatility is most likely to backfire. The unpredictable nature of markets makes it difficult even for professional fund managers to time the market.

The right approach to keep your focus on long-term goals is not to get disillusioned by disappointing short-term returns from equity funds. The key is to analyse their performances vis-a-vis benchmarks and the peer group. Even the most consistent fund managers are likely to deliver negative returns when markets correct. Therefore, short-term negative returns, in line with the market, from a fund that has been doing well for years, doesn't warrant any reaction. 

Similarly, even a poorly performing fund could give decent returns when the markets are doing well. Also, the impressive returns may be due to the aggressive investment strategy of the fund manager and that may expose you to higher risk than your accepted level.

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Finally, you must have a strategy in place to rebalance the portfolio, if need be. No doubt, it can be tough at times to redeem in a rising market or to invest in a falling market. However, rebalancing imposes discipline and ensures that your portfolio mix doesn't take you beyond your defined risk profile.

By: Hemant Rustagi
(The writer is CEO, Wiseinvest Advisors)

Source: DNA Money