As long as fluctuations are within range, you should stay put with your investments.
Everything in life comes with risk. The same goes for your investments. It is important to note here, that talking about risks in your investments is not about discouraging you, but about the right perspective. Even if you are not aware of them, risks abound. But, when you are aware, you are better informed and can think about mitigation.
The major and most prevalent is the volatility risk. When you are investing in the markets, be it equity or any other market, price levels are bound to fluctuate. In some markets such as equity or gold, the extent of fluctuation is relatively higher, while in others such as fixed income, it is relatively lower. In some markets like real estate, the price discovery does not happen every day, hence the level of fluctuation is lower.
Apart from the general measures of market volatility, how do you measure the volatility in your portfolio? There is a concept called mark-to-market, which indicates the price you would realise if you were to sell your portfolio or sell that particular holding. To be noted, it is ‘if’, that is you are not actually selling your portfolio every day; it is just a measure which is reflected in your statement of holdings. You need not be unduly worked up in times of negative volatility.
The perspective for you here is the extent of volatility that the market has seen historically. Unless there is a fundamental change in that market and as long as the fluctuations are within the range, you should stay put. What then is the mitigation for this risk? Time is a critical factor in tempering the effects of volatility. As long as you have time on your side and are not in a hurry to exit from that investment, there is nothing to worry. Time heals not just emotional wounds, but market corrections as well. The question for you here is: ‘what is an adequate time frame that would take care of any transient market turbulence?’. The ballpark guide here is 10 years, and if you can make it even longer, say 15 or 20 years, you are not only safe, but can expect to earn decent returns.
The other question for you is: if the time horizon is not as long but say five years, what should you do? Then, exposure to relatively more volatile investments like equity or gold should form a smaller part of your portfolio and relatively more stable ones such as fixed income should be higher. The rationale is, over a period of five years, volatile ones like equity can give you high returns if they are on the right side but on the wrong side, it would not impact you much.
The next major risk aspect is credit risk or default risk, which is typical of fixed income. There is no default risk in equity, as your returns are driven by market price movements. In fixed income, your money is due from somebody on maturity: bond maturity is due from the issuer, deposits from the bank or corporate and the like.
Here, the mitigation factor is the profile of the entity from which your money is due. There are certain government or quasi-government entities, which are highly safe
The Reserve Bank of India issues bonds and the small savings schemes are administered by post offices; these are all part of the government machinery.
Among banks, you have to look at the ownership and performance profile. Public sector banks are safe by virtue of government ownership, though protection of funds is not a stated guarantee. Among private banks, there are the leading ones that are doing well and are safe.
In the cooperative banks space, issues with regard to safety of deposits have arisen; hence you need to be careful. Bank deposits up to ₹5 lakh are secured by the Deposit Insurance Credit Guarantee Corporation.
Beyond that, the profile of the bank should help you decide. Then, there are deposits accepted by certain corporates and bonds issued by various types of issuers. The parameter to watch out for is the credit rating. ‘AAA’ is the highest credit rating denoting best quality, followed by ‘AA’ and so on.
Apart from direct investments in equity stocks or bonds, you may invest through mutual funds (MFs). Here, volatility risk is reflected in your statements. Returns are computed on the basis of the net asset values (NAVs) of your funds, which reflect the market price of that day and of the securities in the portfolio of the fund.
Over a short holding period, market movement may or may not be in your favour. Over a long period, market cycles play out and things even out. You need not check your portfolio statement every day.
Check it periodically, say, once a month. As long as you are clear about your investment time horizon, just hold on. On the fixed income oriented funds, you may look at the credit rating of the instruments in the portfolio i.e. AAA, AA etc., which conveys the credit quality.
There are government bonds in some debt funds, which are safer than even AAA-rated instruments.
There are certain other types of risk in the portfolio construct, which you should keep in mind. One is concentration risk. This is about your portfolio being spread across a relatively lesser number of instruments, which implies that if something were to go wrong in a particular equity stock or bond, you are exposed to that extent.
MF portfolios are already spread out across adequate number of securities, hence you need not buy into too many funds.
If you are doing the portfolio construct yourself, you should buy instruments across categories and have an optimum number. Liquidity is another aspect to note, in case you need access to funds prior to maturity or intended holding period.
Investments such as RBI bonds are not redeemable. In equity stocks or equity MFs, you can sell any time, but if your holding period is short, your returns are subject to market movements.