Equity Archives - Page 2 of 2

Factors affecting the stock market

If you have been a stock investor for several years, you should have known by now that a stock’s demand and supply dynamics are not the only thing that moves the stock market. There are many other factors including news that affects the stock markets. The news can be any kind of news such as stock specific news, macro-economic news or global market news.

Markets don’t react to only news that has already broken, they react to anticipated news too. In fact, markets react more rapidly to rumours and theories. Our stock markets have the tendency to discount events much before they happen. So, here’s a look at all the factors that will affect the stock market.

Institutional investor inflows

This is one of the most important factors that have a major influence on the market sentiments. Institutional investors include Foreign Institutional Investors (FII) and Domestic Institutional Investors (DII). FIIs invest into the Indian markets for many reasons including the fact that interest rates here are higher than in developed markets and emerging equity markets have the potential of providing higher returns than those in developed nations. DIIs include mutual funds that buy shares and bonds.

FIIs and DIIs with their huge amount of investible surplus have the ability to turn around market sentiments when they deploy money in the equity market. Take for instance, the month of January 2020. FIIs were net sellers during the month and according to the Securities Exchange Board of India (SEBI) data, their net outflows from the equity markets during the month totalled Rs 5,359 crores. The Sensex lost over 3.3% during the month.

Interest rate changes

The interest rates in the country affect a number of major economic factors including bank deposit rates, loan rates, demand for goods and services, consumption, industrial growth, among others. Interest rates have an impact on the stock market too. Any major change in interest rates affects the ‘rate sensitive’ sectors of the stock market more than the others. These include banks (which provide loans), automobile companies (which depend on consumers who avail auto loans) and real estate (which depend on people who avail housing loans).

Data

There are several Indian as well as international economic data that are released every week, month or quarter that has an impact on the stock markets. These include Index of Industrial production (IIP), Gross Domestic Product (GDP) estimates, manufacturing data, consumer sentiment, among others. Markets react within minutes to news on these numbers being released. Not only national, international economic data also has an impact on Indian markets.

Currency movements

Depreciation or appreciation of the Indian rupee against the US dollar, British pound and other currencies always has an impact on the equity market. Rupee movements also have an impact on certain sectors that import or export goods or deal with foreign clients.

Monsoon

India is largely dependent on the monsoon every year for staples such as rice and wheat. So, any news on the monsoon has a great impact on the market. A favourable monsoon tends to have a positive impact on the markets.

National/International events

Union Budget, RBI policy reforms, national or state elections – you name any political, economic or national/international event; they have an impact on the stock market. For instance, a surge in coronavirus cases outside China triggered a selloff in global equity markets on 24^th Feb, 2020. Indian markets were affected too. Indian stock market benchmark Sensex tanked by over 800 points to 40,363.23, wiping out over Rs. 3 lakh crore of investors’ wealth.

Investor confidence and expectations

A key factor that sways the market is the mood of the investors. If they receive positive news that gives optimism then they are more likely to buy shares. If they receive bad news they will sell. For instance, if investors feel the worst for the economic recession is over, the stock market can rally even when economic fundamentals remain poor.

Inflation

Inflation is a huge driver of the stock market. Historically, low inflation has had a strong inverse correlation with stock valuations. Deflation, on the other hand, is generally bad for stocks because it is considered a loss in pricing power for companies.

Unusual Transactions

Any purchases or sales of a stock motivated by something other than its intrinsic value can move the stock market. Transactions such as executive insider trades can have an impact on the equity markets.

Liquidity

Market liquidity is an important factor. It refers to how much interest investors have in a stock. Liquidity is about the trade-off between the speed of the sale and the price it can be sold for. In a liquid market, you can sell quickly without the sale reducing the price much. In a relatively illiquid market, selling quickly will result in fall of price by some amount.

Large-cap stocks have high liquidity as they are well followed and heavily transacted. Many small-cap stocks have liquidity issues because they simply are not on many of the investors’ radar screens.

Apart from all these factors, it would be prudent for you to note that you should not take any decisions based on any of the news unless it is company specific. Always look at individual companies and their long-term earning potential. When you hear company specific news, confirm the same from the company to verify if the news is true or false.

If you are not sure about how to invest in stocks, invest in mutual funds. They invest in stocks on your behalf and have known to give better returns than traditional investments in the long-run.

What’s the difference between arbitrage and equity savings funds?

As you might know, arbitrage funds make profits or hedge risks from buy-and-sell opportunities in the cash and the derivatives market. Whereas equity savings funds invest in equity, arbitrage and debt. They are allowed to invest a minimum of 65 per cent in equities. This will include arbitrage positions. They have a minimum of 10 per cent in debt too.

So, arbitrage funds and equity savings funds have only one thing in common. Both of them aim at reducing the volatility in returns using arbitrage. Now, what is arbitrage? Arbitrage is taking advantage of price differentials of the same stock in different markets. So, the stock will be bought in one market at a lower price and sold in another market at a higher price. Which markets are they? These are the cash and the derivatives markets.

Funds take opposite positions in each of the market. For instance, they may take a buy position in the spot market and sell position in the derivatives market to make profits or hedge or counter the equity risk. Essentially, the equity exposure of the fund’s portfolio is covered by the derivatives position. How does this help? Let’s say the stock the fund has purchased falls. The fund has already taken a sell position at a higher price in the derivatives market. This will prevent the fund’s portfolio returns from dipping.

Arbitrage opportunities are abundant only in volatile markets. If funds do not find arbitrage opportunities, they invest in short-term debt securities to lower equity risks. So, there ends the similarity between arbitrage and equity savings funds. Let’s look at the differences.

The differences

Portfolio

Arbitrage funds take offsetting positions on their entire equity portfolio in the derivatives markets. They leave a very small portion of their portfolio unhedged or open. As a result, the volatility of returns is neutralised in arbitrage funds and they will not see steep and frequent falls or rises.

Equity savings funds are an amalgamation of balanced funds and arbitrage funds. They have a portion of their portfolio in debt and the remaining in equity and some part of their equity will have arbitrage. Note that the equity portion will not be hedged completely. These funds leave a portion of their portfolio unhedged. This can be more or less based on their market research. If they feel that markets can move higher, they could decide to have a higher open position to maximise the gains.

There are equity savings funds that hold direct equity. They can actually hold significant amounts of direct equity. This means that they can have a net long equity exposure. In simple words, the extent to which they can buy stocks can be more than the extent to which they short the stocks. There are funds that are allowed to invest in foreign stocks. So, the risks are higher for equity savings funds.

Returns

Arbitrage funds will not deliver returns that match equity funds. This is because any price gain in stocks they hold will be limited by the opposite position they take using derivatives. Arbitrage funds usually provide returns that are slightly higher than short-term debt funds. In times of low arbitrage opportunities, their returns might get hit and they could fall to be on par with liquid or ultrashort-term funds.

Equity savings funds tend to provide higher returns in the short term because of their equity holdings. These returns tend to get averaged out in the long run. For instance, the one year return of ICICI Prudential Savings Fund is about 12% while the five year return is 7%.

Taxation

As per the present tax laws, fund houses are allowed to count derivative exposure as equity. So, arbitrage funds and equity savings funds are considered as equity funds. So, any gains on holdings of more than one year are tax-free up to Rs. 1 lakh. Gains of over Rs. 1 lakh will be taxed at 10%. Short-term capital gains, when the fund is held for less than a year, are taxed at 15%.

Suitability

Arbitrage funds can be considered by those in the higher tax brackets to park their short-term money. Note that arbitrage funds are not a substitute for liquid funds and might have higher risks than the latter. So, remember that arbitrage funds are low risk equity funds and not debt funds.

If you have a time horizon of one to three years and don’t want to look at balanced funds, you can consider equity savings funds. Note that it is best to remain invested in these funds for lesser number of years rather than for the long haul as the hedged portion of the equity will lower returns. Balanced funds capitalise on equity markets adequately and are suitable for long-term portfolios.

Note that under the equity funds umbrella, the standard mutual fund categories are many. This includes large-cap, diversified, mid-cap funds, small-cap funds, multi-cap funds, balanced funds among others. These funds are suited for all investors, depending on their risk appetite and are good long-term investments. However, arbitrage and equity savings funds are not for everyone and some research is needed if you want to invest in these funds.

PMS Vs Mutual Funds: Here is what you want to know

Portfolio Management Services or PMS are similar to mutual funds. However, they are offered only to High Networth Individuals or people having a large amount of surplus money. Most financial institutions promise customisation for your investments and say you will get higher returns when compared to other investments. This may not always be true. Here’s why PMS is not for all.

The difference between PMS and mutual funds

PMS are investment services that are based on your return expectations, financial requirements and risk profile. The services are provided for a fee. PMS are presently offered by independent brokerages, banks, mutual fund houses and other financial institutions.

Mutual funds are investments offered by Asset Management Companies (AMC). You need to choose the mutual fund based on your financial requirements and risk profile. There might or might not be a cost for investing in mutual funds.

Minimum investment

The Securities Exchange Board of India (SEBI) has increased the minimum investment for PMS from Rs 25 lakhs to Rs 50 lakhs. It’s just Rs 500 for most mutual funds and in some cases Rs 100 only.

Customisation

Mutual funds cannot be customised as per the needs of the investors. Even though PMS offers customisation, typically firms will offer this only to those who have a very large investible corpus of Rs 1 crore or more.

Most of the PMS firms including banks offer discretionary PMS services. Here, you will be given a few model portfolios. You need to choose a particular portfolio. The portfolio models will be different in terms of their style of investing. You need to take a look at the past performance of the portfolios.

Terms of investment

Note that PMS is an agreement between you and the service provider. So, the onus is on you to ensure that the terms are in your best interest. If you are investing in mutual funds, the terms are the same for all funds as it will be according to guidelines given by SEBI.

Charges

PMS charges are much higher than that of mutual funds as it provides more customised offering compared to a mutual fund. SEBI hasn’t set any limits for charges for PMS so far. According to SEBI, “a portfolio manager shall charge a fee as per the agreement with the client for rendering portfolio management services. The fee so charged may be a fixed amount or a return-based fee or a combination of both.” So, the cost structure might be ambiguous.

You will find that the charges are usually in two formats. One is the fixed fee model while the other is the profit-sharing model. Some could offer a combination of both. PMS firms will also charge you fund management fees. This will be apart from the depository charges, and GST. For instance, ASK Investment Managers Ltd. charges a fixed fee of 2.5% per year or you can pay 1.5% and opt for a profit-sharing model where ASK will get 20% of the gains if the returns are over 10%.

So, PMS charges can be as high as 3-5% of your investment. You can invest in a mutual fund with under 1% if you choose direct plans. Even if you use an advisor, there are mutual funds with the expense ratio as low as 0.5% of your investment.

Smaller industry

Consider this: The PMS industry is said to be worth Rs. 48,000 crores while the mutual fund industry is worth more than Rs. 27 lakh crores. The PMS industry is minuscule when compared to the mutual fund industry. So, the number of PMS products are also much lesser than the mutual funds that are available for you to invest.

Transparency

PMS firms need to tell you which securities were bought, which were sold and what profits were made. You can also know exactly at what price these investments were made. However, this is at the discretion of the firm. Some firms provide these statements every month while other give quarterly statements. Also updating your investment portfolio will differ from firm to firm. Some firms may update your latest portfolio statements on a daily basis while others might update only once in 15 days. With mutual funds, the NAV will be declared every day and you can get it from any of the financial institutions’ websites.

The returns

As you know, PMS is a high-risk product. The returns will become visible only in the long run. Historical data shows that genuine PMS products can only give you only slightly higher returns than mutual funds. You must understand that it’s not guaranteed you will get phenomenal returns using PMS. Note that according to SEBI guidelines, PMS firms cannot promise even indicative returns, let alone guaranteed returns.

There are a number of things that PMS firms will tell you but you should be proactive and ask them questions instead of blindly believing everything they say.

Lock-in period

PMS products usually have no lock in period. However, most of them have an exit load if you decide to close the account within a year. The average charge could be anywhere between 1.5% and 3%. Most PMS firms will not allow you withdraw partially. With open-ended funds, you can withdraw your money any time. There are funds with no exit loads.

Taxation

Most PMS companies hold stocks in your own demat or account only. So the taxation is like any other equity investment – short term capital gains tax of 15% and long term capital gains tax of 10% for returns exceeding Rs 1 lakh a year.

For equity mutual funds too, the taxation is similar with long term capital gains only 10% if the gains are over Rs. 1 lakh, and short term capital gains tax of 15%.

Ideally, you should opt for PMS only if you have a corpus of at least more than Rs 1 crore, and you can keep it away for five years or more. It is substantially different from the standard mutual funds. For any other investors with lower corpus, mutual funds are more convenient and easier to invest in.

Should you book your profits now?

If you had invested in the Indian stock markets towards the end of April, you might be sitting pretty today. The Sensex has given returns of 21.99% in the last three months. In the past month, returns are well over 5%, which is much more than what you can expect from your savings account. Even the Nifty has given about 23% in the past quarter. The numbers seem to tell you that you can sell those investments that you hold. However, booking profits can never be based on the markets. Here’s what you need to do when you want to sell your investments.

#1 Take a look at your asset allocation

When the equities portion of your portfolio has exceeded the target asset allocation, then, it is the right time to sell. For example, if you had an asset allocation of 50:40:10 for equities, debt and cash and now that equities have run up, your allocation is 65:25:10, then you will need to sell some of your equity investments and put the money in debt investments to maintain your asset allocation. This is essential for the risk averse investors more than the risk-taking investors. Look at realignment if your target asset allocation has changed by more than 5%. This is because realignments come at a cost that includes transactions costs and capital gains taxes. However, if your asset allocation is just fine, you can afford to stick to your equity investments as they will give good returns in the long run – this is if you have chosen the right stocks and mutual funds.

#2 Consider your goals

It is prudent for an investor to make allocations based on the time horizon for their financial goals. If you have invested for the long term, you shouldn’t sell your equity investments. However, if you had invested for a medium-term goal and your goal is just a year or two away, then, this is the right time to sell off those equity investments and put them into debt investments to safeguard the capital and the gains from your equity investments. When you invest for the long term (that is more than 5 years), it doesn’t make any sense to book profits in a year or two.

#3 Evaluate your target portfolio returns

An investor should always look at reasonable returns from his/her portfolio. If the returns exceed their expectations, it is prudent to book profits in the asset class that has outperformed. If you want to achieve your financial goals, you have to book profits only after any of the asset classes have outperformed significantly. For example, let’s say you were expecting returns of 15% from your equity investments. However, they have given returns of 21%. Now, you should book partial profits and see if you need to put more money in equities or debt investments.

#4 Talk to your financial advisor

If you are an intuitive investor who thinks that there are certain stocks or mutual funds that have given stellar returns only because of the pandemic and may not outperform in the long run, talk to your financial consultant at Welathzi. They will be able to help you with market trends, industry data and fund information that can help you assess whether you should hold on to a stock or mutual fund. If some stocks or funds such as credit risk funds have gone out of favour, consider exiting them. They can help you invest in alternate asset classes if you are selling your investments. However, it is wise not to invest in asset classes that have already done really well. For example, the one-year return for gold has crossed 50% and investments in gold at this point may not yield reasonable returns in the long run. Your common sense and the consultant’s financial literacy will help you make the right investment decisions.

#5 Find out the value of your investments

The value of your investment is not the price of the stock or the Net Asset Value (NAV) of the fund. It is the value of the business for the former and the right portfolio for the latter. When a fund is underperforming when compared to peers or a stock seems to be running out of profits, you can consider selling the investment and look at investing in other stocks or mutual funds. You can even consider cashing in when the fund’s objectives change or the stock’s business isn’t lucrative anymore. So, when it comes to selling decisions for stocks and mutual funds, always assess the individual investments rather than looking at market trends.

Doubts? Wealthzi can help you. Get in touch with your consultant now.

How to assess your risk profile

Risk profile is a measure of how much risk one should be taking while investing after considering all the factors such as one’s financial situation, needs and attitude towards losses. Risk means different things to different people. So, the risk levels vary.

What is risk?

The definition of risk is the degree of uncertainty or potential financial loss present in an investment decision. Now, when you look at ‘risk’, what do you feel? Do you see opportunity or fear? Do you fear those losses? Or do you believe that risk is an integral part of the investing process?

The answers to these questions will help you understand your risk tolerance. You need to focus on your behavioural tendencies. For instance, try and recollect how you reacted to the last loss you saw on your portfolio or whether you invested more when the markets crashed last time.

Your risk tolerance is a combination of your thoughts and your actions towards your investments.

What is risk tolerance?

Risk tolerance is said to be the degree of variability in investment returns that you are willing to withstand in your financial planning. In simple words, risk tolerance is the level of risk you are willing to take with your investments. Even though it may not be possible to gauge your risk tolerance accurately, you can have a good idea about it. While risk is about making gains, exploiting opportunities, it is also about tolerating the possibility of losses and the ability to withstand market volatility.

Behavioural scientists say that the fear of loss plays a bigger role in investing than the anticipation of gains. Since risk tolerance is about your comfort level with market uncertainty, potential losses will help you understand your risk profile.

Note that risk taking capacity is different from your risk tolerance.

How is it different?

Risk capacity is a mathematical measure of how much risk one can take before it affects their financial goals. Note that it is about your ability to take risks and not willingness. Risk capacity is based on your financial situation. Risk tolerance is attitudinal and may or may not change throughout your life.

However, your risk capacity will change depending on your finances, life and financial goals. Even the time horizon needed to achieve those goals will have an impact on your risk capacity. For instance, if your kids are set to go to college in a year or two, you may be less likely to take on high-risk investments. However, if you are single and have no dependents, you might be willing to put your money in riskier investments.

Changing life circumstances will also change your risk capacity. For instance, a job loss or an accident leading to disability can change your risk capacity. Even an inheritance that you receive will change your risk capacity. So, risk capacity is how much you can afford to take and risk tolerance is how much risk you are willing to take.

Your risk tolerance is decided by a combination of factors such as your life goals, your investment experience, time horizon for each goal, your financial situation, and your ‘fear factor’. A simple way to determine your risk profile is using the ‘age-based’ risk tolerance method. As you might know, a young investor having a long-term time horizon for his/her goals can take more risk. So, the ‘age-based’ risk tolerance method says that an older individual will have a short investment horizon and will have a low-risk tolerance.

How to understand your risk tolerance?

However, this method has several flaws. For instance, just because you are retired you needn’tshift all your money to conservative investments such as fixed deposits. Note that only equities can give you higher returns in the long run so they shouldn’t be dropped from your portfolio. With only debt investments, you might get lower returns. With today’s advanced medical science and higher life expectancy, the 60-year-old investor may have 20 or more years to live. So, use this as just the base for deciding your risk tolerance. Combine with factors such as your attitude towards losses, your finances and your need to take risk to assess your risk profile.

What are the limitations?

Your finances will limit your risk tolerance. An investor with a high net worth can take on more risk. The more your net worth, the more aggressive your risk tolerance can be. Those with limited capital are often drawn to riskier investments because of the lure of easy profits. They think they have higher risk tolerance and their risk capacity is low. They shouldn’t take decisions based on their risk tolerance alone. When too much risk is assumed with too little capital, they can be forced to sell. Always combine your risk tolerance and risk capacity to take investment decisions.

Finding your risk profile is a complex process of analysing your finances, needs and attitude. You can take the help of consultants at Wealthzi.com to make investments that are right for you.

How to make sure you are creating enough wealth

Whenever you think about your finances, the primary thing you should ask yourself is whether you are making enough wealth. Why? The response to this inquiry will assist you with accomplishing all your money related objectives. To see whether you are making wealth for every one of your objectives, you have to evaluate the amount of cash you will require for these objectives. How can you find that out?

As a matter of fact, you should contact a financial consultant such as Wealthzi.com who will have the resources to give you an estimate of the amount you will require for every one of your objectives. However, if you are working it out all alone, you can utilise a number of tools available online. Do consider inflation when you use those calculators. Finding the amount you require for every objective will let you know whether you are making enough wealth. Let’s consider an example to understand this.

Retirement

One of your financial objectives is retirement. Suppose you are 28 years of age and will retire when you turn 58 years. You hope to live until you are 78 years of age. If your current month to month costs are Rs. 25,000, what amount of money will you need for your retirement? You will require Rs. 3.85 crores in corpus. It doesn’t stop here.

Imagine a scenario where your yearly costs are higher and come to Rs. 5 lakhs and you intend to go on journeys and getaways for which you will spend Rs. 2 lakhs? At that point, you will require Rs. 5.9 crores as retirement corpus. This is without considering inflation. If you consider inflation to be about 6%, you will require Rs. 5 crores corpus for managing an income to meet your month to month costs alone. If you need to spare that much when you resign, what is the sum you have to contribute now?

If you need to put aside that amount for your retirement, you should contribute at least Rs. 5 lakhs if the return on your investments give you 7% or Rs. 3 lakhs if your investments will give you over 10% every year. Think these amounts are tough to calculate? Take the assistance of consultants at Wealthzi.com. When you are finished assessing the sum required for every one of your objectives and the sum you have to contribute, you should take a look at the investments that you can make to create enough wealth to achieve your goals.

What are the investments?

This is the next million-rupee question at the forefront of your thoughts. Since most monetary objectives are long haul ones, you should put resources into riskier instruments with the goal of making better returns. The best investments will be stocks, mutual funds, post office savings such as Public Provident Fund (PPF) and other such securities. Since you are investing over the long run, it doesn’t make a difference if the investments have a lock-in.

The most ideal approach to making wealth is to put resources into investments that are well regulated. These will include bank deposits and mutual funds. Despite the fact that mutual funds are well managed, you should do a considerable amount of research if you are investing on your own. Try not to take on funds that are not straightforward. These include investments, for example, in thematic funds. For these you need the help of a financial planner.

You also need to understand the investments, the risks involved and also the tax implications. You should peruse the terms and conditions cautiously, particularly for investments such as Unit Linked Investment Plan (ULIP).

In the event that you are running on a strict spending plan, start with a modest quantity of investments consistently and afterward step it up each year as you get pay hikes. You should attempt to increase your investments in any event by 5%-10% consistently to make enough wealth for your objectives. Ensure that you assess your investments at least once every year.

Having said that, the manner in which you contribute to investments will be dependent on your age as your wealth will diminish as you go past every one of your objectives. That is the reason why you have to design your portfolio according to your age to make enough wealth.

For instance, in your 20s, you might be into your first job and be single. Regardless of whether you have dependents or not, you need to begin setting aside your cash. The earlier you begin setting aside, the more cash you will have when you begin making investments for your objectives. For example, if you can invest Rs. 10,000 in your 20s, you will have Rs. 6.4 crores when you retire from work. Even if you start investing Rs. 20,000 after you turn 30 years of age, you will have just Rs. 4 crores when you retire.

To make enough wealth, use your salary hikes to step up investments for your objectives and make sure that your loans are within 50% of your take-home. For instance, if your salary is Rs. 90,000 per month, your loan EMIs shouldn’t exceed Rs. 45,000 per month. Never use your retirement savings for any of your other goals.

Always review your portfolio consistently and align it to your life goals and financial requirements.

How changes in interest rates affect your portfolio

Consistently, the Reserve Bank of India (RBI) changes the interest rates in the nation utilising its fiscal strategy. This influences various loans and deposits. You realise that loan rates change. Nonetheless, do you realise that your investments get influenced as well? Interest rate dynamics affect your investments too. In the recent years, RBI has been cutting interest rates. s

Why the rate cut

Lower loan costs encourage consumer spending in the economy. This gives the country a lift when it is in the midst of slower economic growth. Lower interest rates mean lower loan rates and this urges enterprises to obtain and put the cash in maintaining their business. When organisations progress well, the economy does well too.

In this way, the RBI utilises the fiscal strategy to keep the economy fit as a fiddle. At the point when the economy is developing and in great condition, RBI takes measures to increase loan costs to keep inflation under control. RBI controls the repo rate, which impacts long term loan fees in the nation. Repo rate is the rate at which RBI lends cash to banks in case of any deficit. By setting the repo rate, the RBI in a roundabout way changes long term interest rates, which boosts spending and in the long run encourages industrial and economic prosperity.

Now, how does this affect your investments?

Stock investors

Interest rate changes do not have any direct impact on your stocks. However, RBI’s actions can have a trickle-down effect. For instance, when RBI increases interest rates, banks increase their loan rates and increased rates for business loans can cause companies to halt expansions and reduce employment. Reduced business spending will lower the value of a company’s stock. The reverse will be true when RBI cuts interest rates.

However, note that there is no guarantee that a rate cut will positively impact stocks or a rate hike will reduce stock prices. For instance, falling interest rates happen during periods of economic slowdown coinciding with a bear market. So, stock prices might fall. The impact of the interest rate changes will depend on the stock you chose to invest in.

Debt investors

There is a direct correlation between interest rates and fixed income investments. For these investors, change in interest rates can have significant portfolio implications. How? Bonds and interest rates have an inverse relationship. When interest rates fall, bond prices will rise. When interest rates rise for an extended period, bond prices will decrease. Why does this happen? Newly issued bonds will have higher yields after interest rates rise, making bonds with low coupon rates worth much lesser.

Change in interest rates can directly impact bond yields. Long-term bonds having maturity ranging from 10 to 30 years will have substantial effects. Short-term bonds are less affected by interest rate changes.

If you have bond holdings in your portfolio, such as bond funds, liquid funds or money market funds, falling rates mean a lower return on your investment. If there is an increase in interest rates, deposit rates and debt fund returns will go up. However, understand that interest rate changes impact you, as an investor, only if you are going to redeem your bond holdings.

Let’s consider an example. You purchased a bond for Rs. 3,000. The RBI increases the interest rate and our bond’s market value drops to Rs. 2,900. So, the loss is Rs. 100. However, this loss is only on paper and if you hold the bond to maturity, you will still receive Rs. 3,000. Understand that most times bond price decreases will be offset by bond price increases at a later date if you stay invested.

Other investments

If you have invested in commodities, their prices will increase when interest rates fall and prices may fall when interest rates rise. For instance, gold prices touched an all-time high in India after RBI cut interest rates. If you have property holdings, an interest rate cut can be beneficial. Real estate prices are directly related to interest rates due to the cost of financing. Real estate becomes more attractive as interest rates fall.

What to do?

As interest rate changes can affect investments in different ways, there is no single action you can take. Knowing how to manage your portfolio can help mitigate any potential negative effects. Assess your portfolio and look at how individual asset classes are likely to be impacted by the interest rates. Based on how your portfolio is structured, you can decide whether you should take any action.

You should analyse each investment. For instance, in case of stock investments, try and analyse the industries that might get impacted by interest rate changes. Cyclical industries such as financial institutions, industrial companies, and energy providers tend to perform better when rates rise. Real estate, utilities, and telecommunication, might perform well when interest rates fall.

If you don’t want to do all this, just build a diversified portfolio made up of quality stocks and bonds. Diversifying can help preserve your overall investment portfolio from the negative effects of changing interest rates in the long run. With a balance of stocks and bonds, your portfolio will be better positioned to maintain stability.

Work with wealth consultants at Wealthzi.com to understand how you can minimise the risks arising from interest rate changes to your portfolio.

How to rebalance your portfolio

When you set up a portfolio, you will have an asset allocation for your portfolio. Asset allocation is an investment strategy that helps balance the risks and rewards associated with investing by apportioning the portfolio’s assets as per your goals, risk tolerance, and investment horizon. In simple terms, you will set the percentages for investments in debt and equity and the cash that you will maintain. However, these percentages don’t remain the same throughout your investing horizon. They change based on the equity and debt market movements. Let’s understand how this happens.

Let’s say given your risk tolerance, financial goals and their time horizon, you have decided that your portfolio should look like this:

Asset	%	Rs.
Equity	60	6,00,000
Bond	35	3,50,000
Cash	5	50,000

Over the years, the markets seem to be doing really well and a couple of your shares zoom ahead and before you know it, your portfolio changes to:

Asset	%	Rs.
Equity	71.0	11,00,000
Bond	25.8	4,00,000
Cash	3.2	50,000

You might want to ask, ‘What’s the problem? I gained Rs. 5,00,000 – isn’t that a good thing?’ Of course, it is. However, the problem is that, you have moved away from your original asset allocation and possibly exposed yourself to more risk than is not in line with your risk profile.

This is where you, as a sensible investor, should take some action to bring the portfolio back to the original asset allocation. This is rebalancing.

What is rebalancing?

Rebalancing is the process of buying and selling parts of your portfolio in a bid to rearrange the weight of each asset class back to its initial proportions. In simple terms, it is returning your portfolio to the proper mix of equities, debt and cash when they no longer conform to your financial plan.

Portfolio rebalancing will help you keep your portfolio in line with your financial plan. Understand that rebalancing is not an endeavor to time the market. You need to consider it as a timely reassessment and modification of your investments that will help you reach your goals while ensuring that your risk profile isn’t ignored.

How to re-balance your portfolio

There are different methods for rebalancing your portfolio.

Calendar rebalancing

Calendar rebalancing is the most basic approach. This involves analysing your investments in the portfolio at scheduled time intervals and then adjusting them to the original allocation at a preferred frequency.

Quarterly assessments might be preferred for equity investments because monthly or weekly rebalancing could be overly expensive. A yearly approach could also be considered if you have a higher risk appetite. You should determine the ideal frequency of rebalancing based on time constraints, transaction costs and your risk profile. A major advantage of calendar rebalancing over other methods is that it is less time consuming and least expensive for you as it involves less trades and the assessments are made at pre-determined dates. The downside to calendar rebalancing is that it does not allow for rebalancing on a more dynamic basis even if the markets change significantly.

Here’s how to rebalance using calendar rebalancing.

First you need to record your investments. If you have decided on an asset-allocation strategy and have purchased the right securities in each asset class, keep a record of the cost of each investment at that time, as well as the total cost of your portfolio along with the percentages for each of the asset classes. This historical data will help you compare them with present values in the future.
On a chosen date, review the value of your portfolio and of each asset class. Calculate the percentages for each asset class in your portfolio by dividing the value of each asset class by the total portfolio value. Compare this to the original percentages. Note if there are any significant changes. If not, it may be better to remain passive.

Constant rebalancing

A more responsive approach to rebalancing is constant rebalancing. Every asset class is given a target percentage and a corresponding tolerance range. For instance, an allocation strategy might say that the requirement is to have 30% in mid-cap equities, 30% in blue chips and 20% in bonds with a range of +/- 5% for each of these asset classes. Note that mid-cap equities and blue chips can fluctuate between 5% and 35%. When the percentage of any one asset class moves outside the allowable band, the entire portfolio needs to be rebalanced to reflect the initial asset allocation.

You can use any one of these portfolio rebalancing techniques.

When you find that changes in your asset class percentages have distorted the portfolio, take the present value of your portfolio and multiply it by each of the percentages originally assigned to each asset class. The figures you get will be the amounts that should be invested in each asset class to maintain your original asset allocation.
To achieve the original asset allocation, you could sell off some of the shares where profits have exceeded your expectations and invest those profits in debt. Another alternative will be to look at your other equity holdings and sell the underperformers. You could even introduce new shares or bonds in your portfolio to bring those percentages back to where they were.

It might seem okay to leave the portfolio alone, especially if you have made profits. However, the purpose of having an asset allocation is to achieve the best return for your risk appetite. Doing nothing will violate this. As a rule of thumb, when your allocations drift by 10% or more from your original allocation, you should re-balance. This could happen over time or following an abrupt rise or decline in one or more asset classes.

Portfolio rebalancing helps you stick to your financial plan. You should check your portfolio once a quarter and more frequently if there is significant gain/loss in an asset class.

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