The Indian equity market along with global peers has been trading at higher levels, thanks to liquidity unleashed by central banks and low cost of capital in most parts of the world. But what could potentially derail market sentiment is the action of the US Fed [on rate hike]. That could be the biggest risk for the market over the next two years.
Investing at all-time highs
If one looks through the previous all-time highs (1999, 2007 and 2017), investors ignored asset allocation, i.e. investing across debt, equity and other asset classes. It was an expensive mistake for many as they lost most gains in market correction. To mitigate this, the optimal approach is to adhere to asset allocation at all times.
An investor can opt for hybrid mutual funds, which help address asset allocation needs. In such a fund, the corpus is deployed across equity and debt or equity, debt and other asset classes based on attractiveness. While equity provides growth, debt acts as a cushion against high volatility in equities. Given the active management of asset allocation, such a scheme can be considered part of one’s core portfolio.
Why allocate across assets classes?
Research has shown that the key determinant for successful wealth creation is proper asset allocation. It helps minimise the overall risk to the portfolio. Each asset class has a unique risk-return profile. Also, co-relation between most asset classes is minimal or negative. What it means is that no two asset classes will react to a development in the same manner. Because a portfolio is made up of various asset classes, the negative development in one asset class will not adversely impact the overall portfolio return. This was visible during March 2020, when equity markets globally reacted sharply due to the spread of the pandemic. While equity markets corrected in double digits, gold too rallied. So, if a portfolio had equity, debt and gold, the net impact of the equity market correction would have been dented by gold and the stability offered by debt.