It is often said that investing without a strategy is like traveling without itinerary. In other words, investing without having a plan in place exposes you to the risks of losing your way. Considering that we invest to meet our different objectives covering varying time periods, we need specific strategy and planning to achieve each of them. The investment strategy should broadly guide each of your investment – how much to invest, whether to invest in lump sum or systematically and above all, when to sell.
One of the major challenges that an equity investor has to face is handling volatility in the market. The surprising part is that though ups and downs are a common part of investing in the stock market, not many investors have the temperament and skill to handle these volatile times. Remember if you are a serious long term investor, volatility should be less of a concern for you.
In other words, if you invest in equity as a part of your retirement planning you should not bother about the movements in the stock prices on a day-to-day basis. The most important factors for a long term investor are the quality of the portfolio and the right mix of asset classes in it.
It’s quite common to see investors rushing to sell their equity holdings every time the market turns volatile. Taking money out of the stock market, even for a short period, can prevent you from benefiting from a market rally. While your intention may be simply to wait out a declining period and then get in when the time is right, this strategy can more often than not, backfire.
Remember by not being invested when the market begins a recovery you could lose out on potential significant gains.
While the idea is not to say that you should never sell your investments, making frequent changes in your portfolio can result in lower returns on your investments. This could be because of higher costs due to frequent buying and selling, higher taxes if an investment is not held for at least one year or more and missing out on sudden market rallies.
No wonder, time diversification—remaining invested over different market cycles, is considered extremely important for equity investors. It helps to reduce the risk that you may encounter by investing or selling a particular investment or a category of investment at a bad time in the market cycle. It has much more of an impact on investments that are volatile such as equity or equity fund. If one doesn’t have the capacity ad the temperament to remain invested in a volatile asset class over relatively longer time periods, the right thing to do would be to avoid those investments.
Time diversification is equally important even for stable investments such as liquid funds, short term medium to long term debt funds as well as fixed maturity plans (FMP) of mutual funds. For example, investing in a FMP in the current scenario can be much more profitable than parking it in a liquid fund, especially of the time horizon is known.
Remember your time horizon begins when you invest the money and ends when you need to take the money out. The length of time you remain invested is important because it can directly affect your ability to reduce risk. Longer time horizons allow you to take on greater risks in order to improve your total return potential.
Remember, some of the risks can be reduced by investing across different market environments. Conversely, if your time horizon is short you have greater liquidity needs – flexibility to withdraw at any time with reasonable certainty of value.
Time horizons tend to vary over your life cycle. Most of the younger investors who invest to accumulate money for a long term investment objectives, like retirement have no real liquidity needs, except for short term emergencies. However, younger investors who are also saving for a specific event, such as buying a house or a child’s education, may have greater liquidity needs at different time intervals.
Similarly investors who are on the verge of retirement as well as those who are already retired and largely depend on their investment income have greater liquidity needs.
While moving money from equity into more conservative options like fixed deposits and debt funds may seem like a sensible thing to do, the fact remains that selling in a down market can be a costly mistake. A haphazard and extremely cautious approach exposes you to the risk of falling short of a long term financial goal.