Let’s say you have a goal 1 crore for your child’s education after 15 years and you can save 25,000 every month for this purpose. Then, in this case, you would need an 8.3% return annually. This return will define whether you need to take higher or lower risk. Furthermore, while you may be required to take risk, you may not have a loss tolerance defined by the maximum amount of uncertainty that one can accept.
How much risk can you take?
You may feel ‘okay’ with a 10% market correction as it only takes an 11% profit (from those levels) to offset your total loss. But a 20% loss, for example, is ‘hard’, as it would require a 25% gain to break even. By the same logic, a 40% loss can seem ‘heavy’ as it takes a gain of 67% to make up for this loss, and a 50% loss is even greater, as 100% of the profit is needed to make up for your loss. is required.
Most investors panic when the market is down more than 30% and panic when it goes above 40%. So, the big question is, what shortfall can you realistically handle? Hence, there is a need to make a maximum loss plan.
What can investors do?
Since 2000, Indian equity markets have seen a correction of over 30% in a calendar year on six occasions. In 2000 and 2001, equity markets were down even more – 43% and 42% respectively, while in 2008, they were down 65%.
So, let’s assume that the maximum possible loss on most occasions in a year is 40%. So, what is the maximum loss you are willing to take in your portfolio? Let’s say it is 20%. Then, divide your maximum portfolio loss by the maximum stock market loss that could possibly happen. In this case, dividing 0.20 by 0.40 = 0.50 or 50% would work! So, your target equity allocation should be around 50%.
In addition, it is very important to determine your equity sub-components. For example, investing in midcap and smallcap funds carries a higher risk and therefore may have the potential to see more significant portfolio declines.
Similarly, investing in only a few stocks or relying heavily on employee stock options (ESOPs) increases the risk of non-diversification.
Equity and debt valuations change frequently and asset allocation needs to be changed to reflect this. So, for example, in a 50:50 equity:debt allocation, if equity grows by 30% in one year and the debt portfolio grows by 6%, the equity:debt mix will be revised to 55:45 . To ensure that the potential drawdown in the portfolio does not exceed, reduce the equity stake to the level of 50%. Similarly, in a core-satellite portfolio structure, you need to protect the core from the uncertainties of the satellite portfolio.
return max
After losing 50% in a year, he would need 100% profit to return to the same level. And staying invested can speed up the process. How is that? Often, investors miss out on market gains by trying to time the market.
A study by Motilal Oswal shows that more than 50% of the best 30 days in the last 30 years happened during bear markets. And opting out of it could mean missing out on the opportunity. In the example above, if the market gains 10% every year after a 50% correction, it will take seven years to cover all your losses. Why not 10 years? Thanks to the power of compounding!
During the bull run of 2002-2008, the Nifty 50 had grown nearly six times – from 1,100 in January 2002 to 6,300 in January 2008, at a CAGR of 33% per annum. However, it went through seven double-digit declines, two as fast as 30% during this period. Similarly, from May 2014 to August 2021, Nifty 50 grew 2.5 times at a CAGR of 13%. But, in intermittent times, there were five shortfalls of more than 10%, of which two exceeded 20%.
So, hold on as the good returns will come at the end. The best investors focus on risk management that meets their long-term goals.
Anoop Bansal is the Chief Business Officer of Scripbox.