Focus on building resilient portfolios
At least, the Presidential elections are periodic and are a time-bound exercise, instance of pandemic and recessions are can’t be foretold and planned for. How could one envisage these debilitating scenarios into our investment models?
In the recent past, many investors were waiting for the US election results to be finished so that they could begin investing. True, this is a once-in-a-four-year event and could certainly define the market direction. For instance, during the earlier administration, the corporate tax was cut, while the new incoming President has a clear agenda of increasing the overall taxes and pledged commitment towards green energy and clean Earth. That could lead certain sectors, which are being touted as emerging technologies with futuristic possibilities like wind/solar, electric vehicles, etc. The 'new deal' would allow certain sectors to thrive, while some mayn't attract the market money from the investors.
How does an investor planning for retirement, which is 15, 20 or even 30 years from now, should view these developments? Even in the medium-term timelines of 20 years there would be five Presidential elections and equal possible changes in leadership. Even if the presidents wouldn't change, the possible pivot towards newer planning or strategies could be mulled during their periods. So, should one be making changes every four years to their portfolios or await the election outcome to make fresh allocations?
At least, the Presidential elections are periodic and are a time-bound exercise, instance of pandemic and recessions are can't be foretold and planned for. How could one envisage these debilitating scenarios into our investment models? As we could see that wouldn't help much for investing. What needs to be understood is that while investing for one's needs, they've to always, hence, stick to their risk profile and timelines thus making asset allocations which is diversified to reach goals.
The common adage of 'putting eggs in various baskets' is easier said than done. For instance, when equity markets are clocking new peaks each single day and the news is bombarded on us continuously, it's very difficult to remain an outlier and not participate in the rally. Friend of ours or a colleague or neighbour boasts about the rewards he/she enjoyed being in the market brings regret for not being part of the play. This anxiousness would make one commit mistakes in their judgement in taking a plunge into an investment that doesn't suit despite it being a best performing one.
The pain point of a raging bull rally is that they rarely provide you an exit on the way down. It's here that most are caught and nurse their wounds for a long time. In order to counter such instances, the portfolio should have an exposure across the asset classes like debt, cash equivalents and commodities other than equity. Though being overweight on equity, greater balance could be achieved by having diversification by investing in mutual funds.
The economy and thus the businesses move in cycles. When the businesses thrive, they begin to expand and so their balance sheets. The companies in a thrust to capture newer and greater size could many times raise capital, mostly from debt. The growth phase of the business ensures regular cashflows that help them to service the debt. But, due some external factors, when the demand contracts for their products or services, the very fuel for their expansion would become a huge burden and drag their earning, at times could push them to losses. And when the economic recession takes toll, governments and/or central banks try to incentivize through fiscal and/or monetary policies to revive growth.
Not all businesses contract or perish during economic contractions, there could be some which thrive such conditions. The loose monetary or fiscal policies ignite a fresh expansion by these companies or businesses creating bringing a cascading effect on the rest of the economy. So, that's how the cycles in economy from boom to bust would influence businesses and thus equity. The monetary and fiscal policies also greatly dictate the debt instruments and their performance.
By maintaining a defined exposure to debt and cash equivalents, the portfolio could arrest the loss when the overall equity underperforms. Moreover, please do keep in mind that there have been instances of coincidence of debt yields bottoming along with equity. So, a balanced asset allocation should be that of risk to reward, the higher the ratio, the resilient the portfolio is.
(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at email@example.com)