Sensex is above 50K. Nifty is almost 15K.
In isolation, these numbers may mean nothing. However, the current levels are almost double the 52-week lows formed during the last year. A massive wealth creation over the past year. It does not happen very often that you double your money in just one year, that too by investing in bellwether indices such as Nifty and Sensex.
By the way, did you participate in this rally?
You could have been scared and sold during the market turmoil or during the initial run-up. Or you could have sensed an opportunity and invested heavily and were rewarded. In hindsight, you can say that investing more would have been a good choice. However, in real time, the decision to invest after the economy had come to a grinding halt did not seem an obvious choice.
Well, the past is past. You cannot change it.
What to do now?
Now that the markets have run up to all-time highs, what should you do now?
Sensex at 50K: How do you approach this?
The markets keep making all-time highs on a regular basis. If they were not, none of us would be investing in equity markets. You cannot earn good returns if the markets do not keep hitting new highs. So, 52-week highs or all-time highs are not reasons enough to go slow. In fact, we have seen in an earlier post that investing at 52-week highs has historically been more rewarding than investing at 52-week lows. Not intuitive but such are the results.
Coming back. Sensex at 50K. What should you do?
Should you continue to invest? OR
Should you stop putting in further money? OR
Should you take some or all your money off the table?
Given that the Nifty PE ratio is hovering around 40, you surely need to be cautious. There are reasons that you can ascribe to such high PE levels. For instance, Q1FY2021 earnings were wiped off due to the lockdown. OR the Indian economy is booming or expected to do very well. OR We should look at consolidated PE levels and not standalone levels. OR PE is not the right valuation measure.
Fair enough. All these points have some merit.
However, we can always find reasons to justify almost everything. Given that all kinds of stocks are running up and the valuation measures are at all-time highs (and that has meant lower future returns in the past), there is a reason to be circumspect.
A note of caution: The standalone PE breached 30 for the first time in July 2020. A completely new territory for us. We had never seen PE of 30 before that. Had you taken off your money from the markets at that time, you would have missed 35-40% rally in the markets. So, markets keep bowling googlies. Always keep this in mind.
Diversify. Decide asset allocation. Rebalance
Diversification is NOT about having all your money in the best performing asset all the time.
Diversification is about NOT having all your money in the worst performing asset at any time.
By bringing assets with low or negative correlation in the portfolio, you can reduce portfolio losses and enhance investment discipline (and that’s more important than many of us think). You can add domestic equity, international equity, fixed income, real estate, and gold to the portfolio.
Being in a single asset at any time is just too risky for most of us.
Now that we have decided to be in multiple assets, how much should you allocate?
You should work with an asset allocation approach. And stick to it.
There is no right asset allocation for everyone. A young investor might be comfortable with 70% allocation to equities. On the other hand, a senior citizen may not be able to digest more than 30% equity exposure.
The right asset allocation for you depends on many factors including your risk-taking ability and your risk appetite.
I did an exercise to find the best asset allocation over the last 20 years but that is just an excel based analysis. Take it with a pinch of salt.
You can work with asset allocation ranges
Let us say you decide that you will keep equity allocation between 50% and 60% of your portfolio. 50% and 60% are random numbers. It could have been a different combination.
When you are comfortable about equity market valuation, you can tend to be towards the higher end of the allocation range.
When you are not comfortable about valuations, you can tend to be towards the lower end of the allocation range.
Accordingly, you can rebalance your portfolio at regular intervals.
You can either rebalance your portfolio to move the asset allocation within the target range.
You can adjust your incremental investments so that you move towards the target asset allocation range.
If you leave decision-making to your guts, you will likely mess up
You will either sell too much too soon. OR buy too much too late.
Had I left it to my guts, I would have reduced equity positions sharply in the middle of last year (August-September 2020). While it may still prove to be a good choice over the long term, it would have given me a lot of pain in the short term (I can say that now). Our biases will complicate our investments. And that is never good.
While it is impossible to remove biases from our investment decision-making, we can certainly reduce the impact by working with some rules. And asset allocation is one such rule.
For most of us, over the long term, rule-based investments (decision-making) will do a far better job than gut-based decision making.
Selling all your equity investments (just because you feel markets have gone up too much) and waiting for a correction is likely to be counterproductive over the long term.
Similarly, increasing equity exposure sharply (after a market correction) can backfire. Further correction may await. Or the market may stay rangebound for a few years. This is an even bigger problem when you are talking about individual stocks (and not diversified indices). You may well end up averaging your stock down to zero. Of course, it can be an immensely rewarding experience too, but you need to appreciate the risks. And when you let your guts decide, the risk appreciation usually takes a backseat.
Instead, if you just tweak your asset allocation (or rebalance) to the target levels, you are never completely in or out of the markets. You do not miss the upside. Thus, you will never feel left out (No FOMO or Fear Of Missing Out). And corrections do not crush your portfolio completely either. You will not be too scared during a market fall. Thus, it is also easier to manage emotions. And this prevents you from making bad investment choices.
All this gyan. What should I do now?
I do not know where the markets are headed. I do not know whether we will see 60K first on the Sensex or 40K first. Or whether we will ever see 40K on the Sensex again.
We will certainly see 60K in the future. Whether it happens in the next few months or the next few years (or after many years) is a question.
Now, if 50K on the Sensex looks expensive to you, then you need to check your current equity allocation.
If your equity allocation has moved far ahead of your target allocation, then there is a case for rebalancing the portfolio. Your target allocation was 50%. The current allocation is 60%. You can sell some equity (take some money off the table) and bring allocation closer to target levels. I am not in favour of taking equity allocation to 0% no matter how expensive the markets may seem to you. I am also not in favour of stopping SIPs. Prefer to sell existing investments instead (to get back to target levels) unless tax considerations discourage me from doing so.
If your equity allocation is not far away from the target allocation, you can simply stay put or continue to invest.
About asset allocation and rebalancing, there are no best rules.
You can work with very crisp asset allocation targets. Say 60% equity allocation. You can rebalance to target levels every 6 months or 12 months. OR you rebalance when equity allocation breaches a certain threshold (say, higher than 65% or lower than 55%). And yes, do not rebalance too frequently.
Work with asset allocation ranges. Be at the lower end of the range when the markets look expensive and be at the higher end of the range when the markets look cheap. This approach gives more flexibility. If you feel the markets are expensive now, move towards the lower end of the equity allocation range.