How to avoid impulsive decisions and build a balanced investment portfolio

“Shuruaati Safaltaon Va Wifaltaon Ko Smajhiye Evam Savdhaan Rahiye Janaab.

Safaltaa Ka Nashaa Ya Wifalta ka Bhaya, Kar Sakata Hai Bhavishya Kharaab”

Translation

Understand and beware of early success and initial failure in investment.

The intoxicating success or the frightful failure may ruin the future intent.

Not very long ago, it was a common topic of discussion in social gatherings that how one has invested in cryptos and made a quick buck, making him the person to look up to and follow. As human beings, we are very happy to take the credit of such successes and attribute these gains to one’s intellect and smartness.

In the process of learning and earning faster, this person further redeemed his savings from PPFs, FDs and mutual funds to invest in cryptos, skewing his asset allocation and portfolio diversification. We can very well guess what would have been the aftermath. The cryptos crashed and he wiped out 80 per cent of this net worth.

Another situation, wherein a young investor had just started investing in Jan 2020 with his first job at Nifty 50 index level of 12,352 on 17 Jan 2020 and thereafter market tanked to 7,610 level on 23 March 2020 a fall of 38 per cent, seeing these investors bid a farewell to markets forever and kept on investing in fixed coupon instruments thereafter. Since then, nifty scaled new height to 22338 as on March 1, 2024, generating a total return of 193 per cent at a CAGR of nearly 31 per cent. The above two examples are testimony to falling prey to intoxicating initial gains as well as to frustrating initial loss.

All such investors’ actions depict that human greed, fear and self-confirmation bias taking control over all logical arguments. To quote Warren Buffet, “Emotional makeup is more important than technical skill.” In the above-referred cases both investors or better say, impulsive investors did not have emotional makeup resulting in their predicament.

Wherein the favorable movement in positions made profits and adverse movement made losses. Directional trading requires advance knowledge of technical analysis and momentum trend studies, which requires deep study and time. This isn’t possible at instant to a novice investor. The basic driver of this behavior is FOMO and greed to be better off the lot.

Pandemic has also made masses understand the concept of YOLO, so spending has gone up with people spending more on enjoying experience and latest technology. With the lifestyle of successful young entrepreneurs, (startup founders) being idolized by the millennials and Gen-Z, temptation to make quick buck is always on mind. But investment plan should not be based on FOMO or YOLO. These twin factors should find even less place in execution.

It’s always prudent to set an asset allocation model for your investment. As a basic thumb rule, one’s total equity asset class exposure has to be (100 minus current age), say you are 40 years old, your equity exposure has to be at 60 per cent and rest can be debt asset class. For more mature investors this asset allocation model can be adjusted dynamically, as equity markets are always volatile and tactile asset allocation which is flexible and responsive to changing market environments. These triggers can be set on the index value or portfolio value to optimize the returns.

For example, in a situation like Mar 2020, where in the markets were down 38 per cent, asset allocation model would set higher allocation to equity and lesser to debt. And conversely where the market peaked in Mar 2024, the asset allocation would see a shift towards fixed income or alternative assets. The basic idea is to shift gears of asset amongst the asset allocation dynamically to optimise portfolio return. The most important part of asset allocation model is to decide on the trigger-point well before investment is done. Please stick to your model religiously. To quote Morgan Housel, author of the Psychology of Money, “The hardest financial skill is getting the goalpost to stop moving.” The moving goal post can never be reached.

The golden rule in investing is sticking to asset allocation and diversification. Portfolio must be rebalanced once the goalpost is reached. Further, be consistent and let the compounding work in your favor. There are no short cuts to get rich overnight.

(The writer is Senior Vice President, SBI Funds Management Limited)

(Translation & Synopsis by Hussain Nagarwala, Dy. Vice President, SBI Funds Management Limited)