Bulls and bears play see saw in equity markets. It is easy to get carried away on both the sides – being over optimistic and investing as high prices or being over pessimistic and selling at low prices. Where are we now?

Headlines

Mint on Mar 7

Mutual funds’ AUM hit record high of Rs17.9 trillion in February

One of the leading brokerage houses comes up with a research report titles those ill fated words that are responsible for most of the crashes:

This time it’s different.

All IPOs are listing at a premium. Lot more companies planning for an IPO.

stock market ipo

Every other day some or the other stock hitting upper circuit.

Where does it lead us from here? Let us go beyond the headlines and get deeper on the data.

Are the markets overvalued?

There are various ways to look at the valuation of the markets. Some people use P/E (Price to earning ratio). While other use P/B (Price to book value). Some even try to compare Market cap to GDP ratio. There are many more factors you can look at. But as they say, statistics hide more things than they reveal. Almost all factors can be misleading. Take for instance the case of high P/E. A high P/E can mean a overvalued market. Or it can just mean that earnings were low because of sheer cyclicality in the business. As we had seen in the last quarter, earnings of a lot of companies fell because of demonetization.

Bottomline: It is just too hard to predict whether markets are overvalued or not! Harder to predict the future direction

What should be done?

So we cannot forecast. It is also difficult to figure out how overvalued the markets are. What should be done then? Here are few things:

Invest through SIP

A Systematic Investment Plan (SIP) allows you to invest some amount of money in mutual funds in a very systematic way on a regular basis. When I say regular basis, it can be weekly, monthly, quarterly, yearly etc depending on the investor’s choice. SIP is a completely pre-planned investment approach and helps you to inculcate the habit of investing regularly and thereby accumulating wealth for the future.

The good thing about SIP is that you are not dependent on the existing market levels. A person who wishes to invest in equities should buy more when markets are low and sell when markets are high. But as we have seen in the past, this cannot be predicted by anyone. Thus to avoid any major losses one can always go ahead with SIP. This way you can protect yourself from the volatile market conditions.

Related article: What are the best mutual funds to invest through SIP?

Dabble in Debt Funds

Debt funds are mutual funds investing in debt instruments like government or corporate bonds. While not completely safe, they are relatively less risky than equity funds. Debt funds are of different kinds depending on the kind of debt instruments they invest in. Some types of debt funds like liquid funds and ultra short term funds carry very low risk.

If you have a large amount of money to be invested, it is better to part in liquid or ultra short term debt fund and then transfer to equity funds at regular intervals over a period of time. This is also called systematic transfer plan (STP). This way you can avoid any repercussions due to volatility in the equity markets.

It is also meaningful to diversify by investing in debt + equity at any time.

Learn more about debt funds: What are Debt funds?

Diversify

Bull markets or over-optimism typically rides on a specific asset class. In the current situation, we can see small cap and mid cap that are driving the markets crazy. At these times, it s very risky to remain concentrated on small and mid cap mutual funds. Diversification across a different category of mutual funds is a better choice. A well-diversified portfolio shall have equity and debt component. Some investors even prefer to have a small exposure to gold as well.

Check out an analysis of a diversified portfolio created based on research by Ray Dalio: All Weather Portfolio

Time to Rebalance

Some investors make it is very objective decision to deal with vagaries of the stock market. They maintain a fixed ratio between debt and equity in their portfolio. Here is an example: let us say you have to build a portfolio with a mix of debt and equity in the following ratio:

Debt: 30%, Equity: 70%

Now, let’s say the equity markets go up and your weights change:

Debt: 20%, Equity: 80%

So you sell equity to make sure your portfolio maintains the same ratio of 30:70 between debt and equity. Similarly, you increase the exposure to equity if the markets go down.

Balanced mutual funds follow this strategy to some extent. Check this article to learn more about the best-balanced fund: How to choose the best-balanced fund?

Always keep some cash

Cash is king as they say. Investors should always have some amount of cash lest the economic situation changes. Here cash does not mean that you need to hoard hard cash or currency cash. Cash == highly liquid money accessible to you anytime. Money lying in your savings account is cash – you can withdraw anytime. However, the problem with the savings account is that the interest you earn on it is very low. It is better to park cash in liquid funds – liquid funds are kind of mutual funds that deploy money in very short term debts. They are relatively very safe and provide better returns. How much money you keep in liquid funds depends on your profile. All your emergency funds should be in liquid funds. Plus any surplus cash you want to keep to invest when you are more comfortable with the valuation of the markets.

Check this article to know more about liquid funds: Top Liquid Funds in India

Do not get carried away

Overvalued markets can bring a lot of unwanted optimism in you. At these time, it pays back to learn from the wisdom of successful investors.

In the short run, a market is a voting machine, but in the long run, it is a weighing machine – Benjamin Graham

Only when the tide goes out do you discover who’s been swimming naked – Warren Buffett

Never invest in any scheme that is based on a metaphor, or anything with the word, “next”, in it (e.g., “this kid is the next Elvis Presley”). You will lose your shirt – Clifford Cohen

The four most expensive word in the English language are ‘This time it’s different’ – John Templeton

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. Warren Buffett

Hope this article helps you ride you through the current exuberance.

Happy Investing!