F(N)AQ: How To Bulletproof Your Investment Portfolio From Market Ups And Downs

Market ups and downs often result in a particular asset class registering strong gains while at the same time denting the value of another asset class to a great extent, implying a negative correlation between those asset classes.?

To understand this, let’s have a look at the present market and economic scenario. Equity mutual funds have been offering high returns, as the stock market has been soaring high after making a strong comeback since March 2020’s market crash, right? Nifty50 has been soaring high around the 17,000 mark (on 27.12.2021), whereas Sensex too is hovering around the high mark of 57,000 (as on 27.12.2021). However, on the other hand, in the same market scenario and economic conditions, the rates and returns of bank fixed deposits and other fixed income securities like debt funds have been on a downfall, with many investors continuing to face poor returns.?

So, suppose in case of a market crash, if you happen to have both debt and equities in your portfolio, the losses from your equity investments are likely to be counterbalanced by the capital appreciation of your debt constituents.? Similarly for any other market fluctuation, having investments across different asset classes,especially those having negative correlation, can offset the losses from a falling asset class through the gained appreciation from the other appreciating asset class. That's what contributes towards creating a balanced portfolio which is ready to tackle market ups and downs.?

Diversification through asset allocation is the key. As mentioned in the previous answer as well, investing in different asset classes, especially those having negative correlation, is a key contributor in bulletproofing your portfolio. Even the commonly heard adage “never put all your eggs in one basket” indicates the same. Hence, it's all about diversification across different asset classes which readies your investment portfolio to face market ups and downs.?

So, instead of solely relying on just one asset class or mutual fund category, go for asset allocation to achieve the twin goals of maximizing returns and minimizing risk. Simply put, asset allocation is the process of diversifying your investments across various asset classes, such as equity, debt, gold, cash, etc., according to your risk appetite and the investment horizon for different financial goals.?

As different asset classes perform differently in varying market market situations and economic cycles, it becomes imperative for you to derive a suitable asset allocation strategy to create a balanced investment portfolio. While there are multiple ways to go for asset allocation, lets discuss some of the most prevalent ones:

Diversification within an asset class- Suppose you wish to invest in mutual funds. Herein you can go for diversification within asset class by investing in different categories of mutual funds within the asset class of say, equity and debt. In your chosen asset class, you can spread your invested money amongst various kinds of securities.

For instance, those holding equity funds can diversify the portfolio through investment in a combination of small-cap, mid-cap, and large-cap funds. Such a form of diversification within an asset class also reduces the risk associated while holding a single type of security and helps to absorb the fluctuations in case any particular type of security isn’t performing well.

Diversification across asset classes-This form of diversification involves investing across different asset classes. Like, those holding equity funds can diversify their portfolio by also investing in debt or hybrid funds, and vice versa. The key benefit of diversifying across asset classes is that if one asset class underperforms, the other asset class can provide a cushion to absorb that loss through its appreciation of returns, just like in the case of the negative correlation of debt and equity!

Geographical diversification- Another commonly adopted way of diversifying investment portfolio is through geographical diversification, which involves investment across different geographic regions or different countries. Many investors tend to opt for this type of diversification to reduce overall risk and improve returns on their portfolio since it involves investment in different financial markets of the world which aren’t closely correlated and therefore, changes in one’s prices won’t necessarily reflect on other markets.?

Absolutely not. In fact, assuming diversification and duplication as the same is a commonly committed mistake amongst many investors. When diversification is mistaken as duplication, it leads to the formation of an inappropriate or unbalanced portfolio.?

While diversification implies investing your money in different asset classes or in different types of securities within an asset class to reduce the overall portfolio risk, duplication refers to the action of creating a portfolio involving the similar type of securities/funds/asset classes that don’t offer anything different to the investor, fail to reduce the overall risk and the returns also continue to remain suboptimal.

That's exactly why it’s important for you as an investor to focus on the aim to diversify and not duplicate, as the former is not about the number of funds or assets held in portfolio, but about investing efficiently for diversification across various asset classes, sectors, etc. in order to build a balanced investment portfolio capable of weathering through market fluctuations.

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