For more than a decade now, we have met different types of clients; some conservative, moderate and aggressive investors. Some wish to focus on short term goals, while others have medium term and long-term goals to take care off.
In this diverse group of investors, when we looked at portfolios of our newly on-boarded clients, we noticed a common trait. Investors were concerned more with their equity portfolio rather than their entire portfolio. The rationale being, “Equities are risky; it can erode capital or/and enable wealth creation. The rest of the portfolio is fairly safe, so why worry about it.” That’s reasonable justification indeed, isn’t it?
This phenomenon is well explained in the Loss Aversion Theory, where for the same quantum of money, investors feel 2.5 times more psychological pain when losses are incurred compared to gains. Naive investors have designed home-made Risk management tools for this purpose. In most cases, they maintain very low allocation to equities ranging from nil to 5%. The balance portfolio is invested in safer instruments which include Fixed Deposits, Postal schemes, Insurance Policies Planning , gold, etc. This way, they ensure their downside is well protected, while expecting super normal returns from miniscule equity allocation.
With such actions, naive investors are shouting out loud, “We need investment advisors to guide us.” Think about it, an investor is excessively obsessed with performance of only 5% of the portfolio, taking 95% of the portfolio for granted. Is this behavior rational or irrational?
In such a portfolio, 95% of the portfolio will deliver approx. 7% returns, while return expectation from equities will be plus 12% to 15%. If projections meet reality such a portfolio will deliver meager 7.45% returns, which cannot beat inflation in the long term. Investors need to allocate their investments in different assets as per their goals and time horizon.
For example, if they have a Financial Planning goal which is 7 to 10 years away then the allocation to that goal should be in equity as over that period, equity volatility gets moderated and returns get enhanced. For short term horizon investors should look at fixed income assets which provide safety of capital. In the endeavor to earn huge returns in short term from equities, investors may take too much risk, relying purely on luck to get the desired results.
On the contrary, if investors focus on Asset Allocation whereby they invest as per their goals and risk profile from a long-term perspective, their investment journey will be way more pleasant. For example, if you have 40% equity and 60% debt, having reasonable return expectation of 15% from equities, the portfolio return is likely to be close to 12%. The major difference being, we are not betting in equities, but investing in it for the long run.
Investors, stop betting on equities with miniscule portfolio allocation, it is not going to help much in the long run. Use suitable Asset Allocation, which enables you to worry lessand reap the rewards in the long run. Simply put, when the whole portfolio works hard for you, the results are likely to be better than a portfolio where only a small portion works hard. The choice is yours!!!