A Quick Guide to Recession Proofing your Investments and Finances
If you have an online demat account and an online trading account, you are all set to trade in equities. However, the best of traders and investors are always tested in challenging market conditions. It is one thing to react to risks like an industrial slowdown but it is another thing to prepare your portfolio in advance for such an eventuality. That is what is called recession proofing your portfolio.
Your investment portfolio should be designed to manage the risk as you create wealth in the long term. But there are some key challenges. Different asset classes are driven by different considerations. There are times equities will perform better and there are times debt will do better. The question is how to build a portfolio that can continue to perform under various market conditions? Here is how your approach to a recession proof portfolio should look.
Risk diversification is the best way to be recession-proof
When you invest in an asset class there are risks involved. For example, equity has market risk, debt has interest rate risk and commodities have price risk. Diversification is all about spreading your asset mix. There is a lot of merit in diversification. It is not just enough to open your online trading account and online demat account and buy shares. The key to creating an all-weather portfolio is to diversify your risk across a variety of asset classes. This will enable you to enhance average returns irrespective of cycles in investments.
An extension of diversification is managing correlations? Even within the equity class, defensive sectors do not move in tandem with the high beta sectors. There are specific asset classes like gold and commodities which share negative correlation with other asset classes. The key to creating a recession proof portfolio is to mix assets that have low correlations or even negative correlations.
Balanced and hybrid funds can be a good mid-point
Balanced funds mix debt and equity to give a calibrated flavour of wealth creation and stable income. Hybrid funds automatically have a recession proof flavour to them. Even within the balanced funds category, there are options available which makes it a lot more flexible. You have balanced funds with a predominance of equities. At the other end you have MIPs with a predominance of debt. These two extremes can be combined with a dynamic investment plan to give more flexibility and discretion to the fund manager. That can give you a very good all weather portfolio approach and most of us tend to underestimate the power of such hybrid funds in managing volatility in markets.
Nothing beats a systematic approach in volatile times
A recession means weak growth, low equity prices and weak NAV. How about making the best of it with a SIP approach? We have heard of the SIP approach to investing quite often, but one of the best ways to create an all-weather portfolio is to adopt a phased approach to investing. When you adopt this approach, the rupee cost averaging works in your favour. This is helpful in all types of market conditions, especially over a longer time frame.
Seriously look at gold as a hedge for your portfolio
One good way to create such a recession proof portfolio is to allocate 10-15% of your portfolio to gold. The advantage of gold is that it automatically outperforms in turbulent market conditions and thus gives you a natural hedge against negative returns in other asset classes. Also, gold has been traditionally uncorrelated with assets like equity and that gives gold a genuine advantage in being recession proof.
Take a serious look at commodities
Commodities are yet to emerge as a genuine asset class in India and hence you need to find ways of allocating money to commodities. Typically, industrial commodities follow a longer down cycle and up cycle and are a lot more predictable. Hence by including commodities it is possible to ride the uptrend, spread the risk of the portfolio and also reduce your exposure to regular asset classes. One can invest in commodities either through commodity stocks or through global commodity funds. In fact, global commodity funds will be the best method of participating in this theme as they represent commodities as an asset class.The key to creating a recession proof portfolio is three-fold. Get your asset class mix right and build in diversification. Then, adopt a more dynamic approach to asset allocation. Lastly, the phased approach always works best.
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How to Balance Between Short Term Returns and Long Term Returns?
The common refrain about investing is that it is a long process hence you must not focus too much on short term returns. But, as Keynes said, in the long run we are all dead and therefore you need to look at short term returns too. Not all goals are long term goals and there are some short term goals too. Hence any investment decision has to be a mix of short term and long term investment returns. Under normal circumstances, there are no tactics required to make a substantial amount of money. It’s a long term process and often requires commitment and patience during market fluctuations. But an important decision is about crafting the fine balance between long term and short term outcomes of your investment.
When to balance: when goals are varied
Typically, most of us have a variety of goals to cater to. Some maybe short terms goals like planning for a car loan margin or a home loan margin. Some goals could be medium term goals like creating a nest egg, buying a second property etc. Then there are long term goals like retirement planning, planning for your child’s college, creating an estate etc. Your investment choice and investment return expectations must be based on the tenure of goals. For short term goals ranging from 3 to 5 years you must prefer liquid or bond funds with limited credit risk. Returns will be low but so will be risk; and the investment will be liquid. For medium term goals, focus must be on G-Sec funds, MIPs and balanced funds. For long term goals, you can look at a mix of diversified equity funds, index funds and multi cap funds since equity gives the best risk-adjusted returns over a longer time frame.
When to balance: when undertone of the market is changing
This is slightly more discretionary in nature. With some detailed research, you can decide to increase the equity exposure when the markets are undervalued compared to historical averages. On the other hand, if the P/E is well above the historical band and the bond yields are moving down, it is time for you to go overweight on debt. Moreover, if you are getting into volatile market conditions, you must look to increase your allocation to gold. Each of these decisions has unique risk and return implications.
How to balance: short term and long term options available
Most of us have heard of short term investments and long term investments, but would not be sure of what they mean. What is the difference between them and what investment strategy is best for you? Short term returns arise from short term investments while long term returns originate from long term investments. Even in case of long term investments like equities, your strategy can be short term trading returns, medium term strategic returns or even long term wealth creation.
Let us understand the long term and short term terminologies. A long term investment is an investment that can be held for a longer period of time. Normally, long term investment is for a period of more than 8 years. On the other hand, a short term investment is an investment that is held for a period of 2-4 years. Investments between 4-8 years are normally classified as medium term investments. Short term investments include certificates of deposit, money market funds, and short term bonds. Numerous people try to play the market or take risks with intraday trading or even with futures and options trading. But it is advisable that one should do appropriate research before going for short term online share trading. Long term investments are safer and suitable for beginners.
Achieving balance is all about paybacks
When it comes to investing, it is essential to discover the right balance based on your individual condition. Before investing, whether it is for long term or short term, set clear objectives in mind. Even though you are interested in short term investments, it is advisable to set aside a share of your money for long term investments. This will safeguard your investments if in case you happen to lose money due to an unexpected market reaction or bad investment selection. Investing is a significant money making tool and not something to sidestep or be scared of, so do it with patience and careful research.
What is Nifty 50?
Nifty is the short form for the NSE Fifty and as the name suggests it consists of the 50 most active and liquid stocks in the Indian markets. Unlike the Sensex which uses 1979 as the base year, the Nifty uses 1995 as the base year since the NSE itself came into existence only in 1994. The chart below captures the Nifty since inception.
What you must know about the Nifty 50
The Nifty is also a general index like Sensex, that tracks the market overall. It is also one of the most actively traded indexes in the futures and options segment and it is available for F&O trading in India and abroad. Nifty is also calculated using the free float methodology where the stocks are weighted based on the free float market capitalization of the stock. While the Nifty was launched on April 22, 1996, it uses November 03, 1995 as the base year with a base value of 1000. That means at the current Nifty value of 11,700 it indicates wealth creation to the tune of 11.70 times over the last 24 years. The index is rebalanced semi-annually and the Nifty values are available on a real time basis during trading hours. Apart from being traded on the NSE, the Nifty 50 futures are also traded on the SGX (Singapore Exchange).
Sectoral and Stock mix of the Nifty 50
There are over 13 key sectors represented in the Nifty but the most significant is the financial services sector which has a weightage of 38.85% in the Nifty. Other than financial sector, energy has a weightage of 15.30%, IT has a weight of 13.67%, consumer goods have a weight of 11.29% and autos have a weight of 6.08%. Put together, the top 5 sectors account for more than 85% of the overall weightage in the Nifty and have a substantial influence on the indices.
In terms of specific stocks the top 10 stocks in the Nifty by weight are as under:
TCS, despite being the most valuable company in India in terms of market cap has a much lower weightage due to its limited free float. Since inception, the Nifty has given an annualized return of 11.04% excluding dividends. The returns would be closer to 12.6% if the annualized dividends were also added. The Nifty currently quotes at a P/E ratio of 29.01 on trailing earnings, a price to book ratio of 3.71 and has a dividend yield of 1.13. All these figures keep changing on a regular basis but they are useful parameters to determine if the market overall is overpriced or underpriced.
The Nifty represents nearly 67% of the free float market cap of the NSE and is therefore fairly representative. It is a very important tool for benchmarking portfolio performance, for index funds / ETFs and for index derivatives used in portfolio hedging.
About 5paisa:- 5paisa is an online discount stock broker that is a member of NSE, BSE, MCX and MCX-SX. Since its inception in 2016, 5paisa has always promoted the idea of self-investment and has ensured that 100% operations are executed digitally with minimal to no human interventions.
Our all-in-one Demat account makes investment hassle free for everyone, be it an individual newly venturing into the investment market or a pro investor. Headquartered in Mumbai, 5paisa.com - a subsidiary of IIFL Holdings Ltd (formerly India Infoline Limited), is the first Indian public listed fintech company.
5 Tips To Get Higher Return From Share Trading
Trading unlike investing appears to be a high risk game and quite often it is. There is no tested method of earning higher returns in trading and it comes with practice in the live market environment. While there is nothing foolproof, here are five tips that can enhance the chances of being profitable.
Focus on a few stocks and build expertise
This is the cardinal principle of smart trading. You can successfully identify opportunities in a large array of stocks. You need to focus yourself on a small universe of around 10 or 15 stocks. There are two reasons for this. Share trading is quite multifaceted because you need to understand fundamental triggers, technical levels, news flows, F&O data, among others. You obviously cannot do that for a large number of stocks. The other most important aspect in share trading is that you are able to commit higher capital when the conviction level is much higher. That is only possible if you focus your time and energy on a handful of stocks.
Focus on the high momentum stocks
To make money in share trading you need to trade frequently. The whole idea is that you churn your capital rapidly and for that you need stocks with momentum. What do we understand by momentum? It is the speed and intensity of reaction of a stock to news, triggers or chart patterns. To cite an example, it is hard to trade frequently in stocks like Tata Power or NTPC because the momentum is very weak. These stocks make small moves over a long period of time. To enhance returns, you need to focus on the high momentum counters.
It is always better to trade in high beta stocks
This point may be related to the previous point but nonetheless, it makes sense to look at it as a separate point. Stocks are typically either aggressive or defensive stocks. Normally, stocks with a beta of less than 1 are called defensive stocks while stocks with beta greater than 1 are called aggressive stocks. Normally, trading and churning is much more profitable when you focus on stocks with a Beta of more than 1.5. That is when you actually get the benefit of momentum working in your favour. High beta works both ways, but that is where short side trading comes in handy, which we shall look at in the next point.
Learn to play the short side of the market
Normally, there is a degree of fear associated with short trading. In fact, short sellers are as important as buyers in the share market. Short sellers play on the selling side of the market when they have a negative view on the stock. You can sell in the cash market and buy back the same day or if you want a longer time horizon, you can use futures or put options. The short side of the market is also not too crowded as most retail investors prefer to stay on the long side. You can widen your share trading horizon by playing the market both ways.
Always trade with a favourable risk-reward ratio
You may wonder what is the role of risk in profiting from the share market. Ironically, managing risk is the key to earning higher returns. The risk reward is the return you can expect for every unit of risk. It is important for 2 reasons. Firstly, it helps you measure the risk properly. Secondly, you can decide on the size of your commitment to the trade based on the risk-reward ratio.
There is really no formula for being more profitable in the share market and you need to figure your own unique method. At least, you can plan to be more profitable!
The Impact of Elections on the Stock Market
After three phases of the Election - 2019, the fate of 302 of the 543 seats in the Lok Sabha is sealed. The remaining seats shall see voting in four more phases over the next few weeks. The Nifty and the Sensex have scaled to new highs ahead of the 2019 elections as was the case with the 2014 elections too. In the last two months alone, foreign portfolio investors have infused close to Rs.55,000 crore and that had driven the rally. But how have markets typically reacted to the elections in the previous instances?
To understand the impact of the elections on the market, we can break up the Nifty movement in - 6 months post-election outcome and compare it with the second scenario when the Nifty returns are calculated for a full 1 year (6 months before and 6 months after election). The chart is quite interesting.
What do we infer from the above chart? Irrespective of whether you bought the Nifty on the Election Day and held for 6 months or you bought 6 months prior to the election and held for 1 year, the returns have been very positive. The only exceptions were the elections of 1996 and 1998, but that is perfectly understandable as these were the years that threw up an extremely unstable coalition that did not last for long. If you look at any of the other governments of 1991, 1999, 2004, 2009 or 2014 where the governments lasted a full term, the returns around the election have been actually positive. It did not matter that 1991 was a minority government while 1999, 2004 and 2009 were coalition governments. So the entire obsession about the need for majority governments for healthy Nifty returns may be a tad overstated.
Have governments impacted the GDP growth and stock markets?
If you take the last 5 elections from 1996 onwards, then the GDP growth in the year after the election has been higher than the GDP growth in the year before the elections. The only exception was the 2009 elections but that was understandable because the world economy was just coming out of recession and that led to slightly lower growth in 2010. Other than that we have seen better GDP growth in post-election years compared to pre-election years.
Frankly, elections should not bother one’s investment decision. There are various reasons that affect stock market, not only elections. Also there is not much of a linkage between elections, GDP growth and stock markets. GDP is being driven by a huge domestic market and a young population. Stock markets are being driven by low inflation, corporate profits and more Indians investing in equities. In fact, Indian stock markets have created wealth irrespective of unstable governments, coalition governments, global crisis, droughts and floods. At best, elections are one more such event for the markets!
The Ultimate Secret for Success in Stock Trading
When King Ptolemy asked the great mathematician, Euclid, for a simpler approach to geometry, Euclid responded, “Your Highness, there is no royal road to geometry”. What was said about geometry many centuries ago is equally applicable to stock trading. There is no short cut to success in stock trading. So, what is the secret success formula that we are looking for? The secret to your trading success is not in the stock or in your online stock broker. It is entirely with you.
The legendary trader, Jesse Livermore, has laid out a complete set of rules for success in the stock markets. If we were to summarize all these trading secrets, we can put them into four key points.
As a trader, always listen to the markets
Every time the market has a story to tell. As a trader, it is your primary job to interpret the market cues and trade accordingly. The trader has to base his performance on facts and not on opinions. As a trader, you must avoid the temptation of trying to be contrarian in the market. If you are bullish and the market is falling, it is basically giving you a message that you have missed out key factors. Listen to the message and modify stance accordingly.
Be thorough in your research
We often believe that traders do not have to research stocks and it is only for the long term investors. That is not true. Even a trader needs to understand the many facets of the stock like company performance, balance sheet strength, impact of news flows, technical charts, among others. That is the only way you can interpret signals and project how the stock will react to news and earning flows. One of the basic secrets here is to start small and then build positions as you build your conviction. Remember that profits are never made in all trades but in a handful of trades. Make them count. Hold on to your profits long enough and cut your losses fast. That is only possible through in-depth research into stocks and markets.
Spread your trades adequately
Don’t concentrate all your capital on just a few trades. While it is necessary that you keep your universe of stocks limited since that is the only way you can trade with insights, but don’t try and focus all your capital on just one or two stocks or themes. For example, if all your trades are focused on banks, NBFCs, autos and realty, then your trades are really sensitive to interest rates. If the RBI announces a hike in the repo rates then all your trading positions will be impacted and losses could be larger than you anticipated. The idea of diversification in trading is to ensure that your trading book is not dependent on just one or two events.
Finally, it all boils down to discipline
You cannot make success of your stock trading activity unless you instill discipline at every level. Firstly, you need discipline on capital protection. Work out the various levels of losses that you are willing to take on an intraday, weekly and overall basis. The moment these levels are hit, have the discipline to shut down your terminal and revisit your strategy. Secondly, stop loss and profit targets are an absolute necessity. You can never be a successful trader unless these two disciplines are instilled. Thirdly, have the discipline of separating capital money and profit money. The levels of risk you can afford to take on both these differ.Ironically, the best of traders are those who get these basic rules right. Trading is not about adding on risks but a lot more about managing risks. Take care of the risks and the returns will take care of itself!