The turmoil caused by the subprime issues in the US is one more reflection of a grim reality of modern times—uncertainty is here to stay. Geopolitical tensions, disasters, asset bubbles…a host of events make the modern financial system volatile. Investors have to take care to ensure that short-term swings do not spoil their long-term financial plans. Here is a seven-point action plan:

Understand yourself: Assess your risk appetite, time horizon and financial goals to check if your current portfolio allocation is in line with your particular situation. In bull runs, the assessment of risk appetite gets inflated, while in bear markets, investors underestimate risk ability. Thereafter, look at your earning, saving and investment potential. This will give you an idea of your ideal asset allocation.

Understand risk-reward equation: Safe investment options like bank deposits, while giving steady returns, lead to erosion of purchasing power due to inflation and taxes. With 5% inflation, Rs 1,000 today will be worth Rs 613 in 10 years; what costs Rs 1,000 now will cost Rs 1,629.

Over the past 27 years, while inflation averaged 7%, one-year bank deposits, the most popular category, gave before tax returns of 7.5%. Stock markets give superior, inflation-adjusted returns. But it’s critical to understand the nature of each asset class and type of returns.

Understand markets: In the shortterm, markets are influenced by sentiments, but in the long-run fundamentals are the key determinants. Indian markets have historically had a decline of about 10% once every two years or so. Even in the greatest bull market (2003-2007), there have been sharp declines. Trying to predict the direction of the market over the near term is an exercise in futility.

Understand long term: Over the past 27 years, the market has yielded a compounded annualised growth of 18% per annum as reflected in the BSE Index. Similarly, from a market capitalisation of Rs 1.6 lakh crore in 1992, the Indian markets hit Rs 45 lakh crore in 2007. If in 1992, we knew our money would go up 28 times in the next 15 years, all investors would have put their savings in the stock market.

Understand diversification: Keep funds equivalent to six months of expenses in a liquid fund or savings account. Use insurance to cover the risk, not as an investment. And diversify investments into a wide range of equities, bonds, real estate, gold and precious metals. The bottomline is to have a well spread out portfolio.

Understand time and timing: Time in the market is important, not timing. Even diversified portfolios can lose ground in a bear market. And it’s easy to be tempted to sell and move to bank deposits to wait for better times. But nobody knows when that day will be. If you miss the bus, you can lose a huge portion of the upside.

Understand SIPs: A systematic investment plan (SIP) involves investing the same amount at consistent intervals, say once a month. Thus you don’t have to try to guess which way the financial markets will move. Market volatility is a fact of life. But by astute financial planning, investors can ride out the waves.

Ajay Bagga is CEO, Lotus India Asset Management