More often than not, investors burn their fingers trying to time the market. It would be more prudent to follow a disciplined investing strategy that offers a risk-reward balance. Before investing, you should define an investment philosophy and assess your objective, suitability and risk profile. Investment objectives need to be based on certain factors, such as personal wealth, age, financial goals, understanding of asset classes, time horizon, liquidity needs, inflation and market outlook.
Disciplined investing requires diversifying investments for a portfolio to balance return and risk. It involves dividing the portfolio among different asset categories. The asset allocation that works best for an investor will depend largely on his time horizon and risk tolerance.
He should also pay attention to structural considerations, such as trusts, insurance, annuities, tax and liability management. Allocation is based on the following steps: calculating rates of return, standard deviation and correlation between asset classes, checking for consistency of returns across economic cycles, optimising the riskreward payoff, evaluating hedging options and deciding if investments are to be made in instalments, which is recommended during volatility.
Asset allocation has evolved over time. Initially, it simply meant spreading eggs across baskets to mitigate risk. Then it moved to a complicated mathematical model, where allocation ratios were based on the risk-return framework and correlation between asset classes. In its most modern form, it is a forwardlooking exercise, which gives significant importance to a qualitative overlay.
This makes it a more relevant exercise than quant-based allocation. With this evolution, the role of tactical asset allocation comes into play. It's a dynamic strategy that actively adjusts a portfolio's assets by taking an informed call in reaction to or in anticipation of certain trends. While the importance of long-term investments cannot be undermined, tactical allocation, if followed with rigour and backed by research, can deliver incremental returns. Once invested, one should periodically review and rebalance the portfolio.
Investors should have a predefined profit and loss booking levels. These should also be reviewed and reset based on the market outlook and changing investment objectives. One should maintain liquidity in the portfolio to take advantage of a windfall. In addition, investors could consider maintaining separate trading and investment portfolios with different investment objectives.
With increasing complexity and lack of time or expertise, smart investors often engage professional advisers to manage their portfolios.
Good investment advisers have the skills, insight and perspective needed to recognise assets or markets that are entering cyclical phases. Finally, never getting emotionally attached to investments is crucial to disciplined investing. There is no harm in booking profits and staying liquid. The markets will always present opportunities to make profits.
