Whenever share prices fall, there is a feeling of despondency. You want to know if you are on the right track with your investment choices. Fund managers, who manage your money at mutual funds insurance companies, often air their views on the market.
Much discussion over the selloff in small and mid-cap companies occupied mind space recently. The brisk selloff in these stocks is a fact. It is also a fact that the prevailing market prices were way higher than the fundamental value these companies bring. An ‘irrational exuberance’ is now on a course correction.
Many mutual fund and equity investors are selling equity holdings as prices fall. If you are invested in borrowed money, you must sell every time share prices fall. Typically, traders will have to adjust their positions based on the market’s direction. While in a rising market, you buy low and sell at a higher price, in a falling market, you sell at a higher price and buy at a lower price.
This column is about personal finance and long-term investing. As a result, any fall in the share prices should not cause panic if your investment philosophy is to hold for the long-term.
It is essential to highlight the letter to shareholders written by legendary American investor Warren Buffett in 1990. He emphasises being an investor who will keep buying parts of businesses through equity investing. “Given these intentions, declining prices for businesses benefit us, and rising prices hurt us,” he told his shareholders.
In a few words, he explains what goes behind stock selection for long-term investing. He further states that the most common cause of low prices is pessimism—sometimes pervasive, sometimes specific to a company or industry.
“We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer,” Buffett argued in that letter.
Drawing from that philosophy, you must look at the fall in share prices as an opportunity. The argument that is being made is that you should sell the risky mid-cap and small-cap stocks and strengthen your exposure to fundamentally strong companies. It is fair advice for those who are actively managing their money.
For the public, the critical bit that comes out of the debate is more about the risk in the equity markets and the need to make the correct asset allocation. You cannot put all your eggs in one basket.
Asset allocation is a process where you put appropriate money in multiple asset classes based on your long-term or short-term goals and ability to take risks.
Your long-term and short-term goals are known only to you. It is a good idea to make a list and categorise them. If you know what expenses you plan to make at various stages in your life, you can create a plan for them. The nature of your financial goals partly determines the pace at which you want to grow your money.
The second important aspect is the risk appetite.
It is a function of your confidence in your future income. It has little to do with age or your life stage. If you are generating a steady monthly income and managing an investible surplus, you need to focus on an appropriate asset allocation to avoid panic situations in the future.
If you are working with a professional advisor, you must discuss the risks to your investments regularly. Risks associated with multiple asset classes vary. Getting professional advice should be a priority for those who have yet to do so. You need more than a family relative to help you understand the nuances of risks. While a plethora of information is available online, you need to make an effort to give your money the right direction.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)