This is the most common question we get from our new subscribers when they enquire about our service. The second question most frequent question is – what do you think about the market?
Both the questions are linked. Let’s explore the assumptions behind these questions.
The investor is trying to time their entry in the market to maximize their return. If they can time the market more precisely, the portfolio returns should improve. That is the theory.
The Time angle
Let’s explore this question first from the time horizon of the individual. For the sake of argument, lets look at the two extremes – one is a swing trader, and the other is a buy and hold investor with 10+ year horizon.
The swing trader has a holding period of 3-6 months and for this person, the near-term direction of the market makes a lot of difference. At the other extreme, the buy and hold investor could care less about what happens in the next 6 months. As long as the long-term economics of the company is intact, he does not care.
We have a time horizon between 2-5 years. For us the near-term direction of the market has some implication, but not a lot. Let me expand on this.
We watch the overall market to look for the extremes. If the market is too frothy and so are our stocks, we start reducing our exposure progressively as we have done in the past. At the other end, when the market gets cheap, we reduce our cash and raise our exposure.
This range is wide and most times we ignore the state of the market. We are focused on the prospects of individual stocks and follow a bottoms up approach.
Asset allocation
This gets to the second element of our process – asset allocation. Although we do not manage this for our clients, we follow a simple approach for our money. We have a pre-decided allocation for equity, debt, real estate and so on. As the markets rise, we rebalance the portfolio to get the allocations back to target.
For example, if the target equity allocation is 70% of our asset mix, we reduce our exposure to achieve the target when markets get overvalued. Selling some of the overvalued stocks and raising the cash levels allows us to reduce risk in the portfolio and achieve the target allocation at the same time.
Combining the two
As long-term investors, we cannot swing from 0% to targeted equity allocation in your portfolio based on market levels. We follow a graded approach of working within a band where we reduce risk to our equity portfolio when valuations get out of whack. That also achieves the asset allocation targets.
Instead of asking whether this is a good time to invest, the better questions to ask are
- Am I below or over my equity allocation in my portfolio? If below I can allocate more capital to it
- Are there opportunities which will do well over 2-3 years and are reasonably priced. If yes, then I can add to them subject to the limits from previous point.
Unless you are a swing trader or position trader, there is no need to agonize over the precise market level. It makes sense to slowly raise or reduce your allocations based on the above two factors.
