Investors often believe that accurately predicting market trends can help them profit whether the market is high or low. So, when they anticipate a peak, they reduce their equity allocation and increase the cash allocation and vice versa. But is this the right investment strategy? What impact does increasing cash allocation have on your mutual fund portfolio? Read on to find out.
Predicting market trends
‘Hindsight is 20/20’—this saying is perhaps never truer than when investors talk about timing the market. A market peak or bottom is easier to identify and more obvious when looking back. The truth is no one can successfully predict market trends. An obvious market peak could turn out to be an ongoing upward trajectory. Similarly, nobody can accurately predict a market fall. A market correction after a market peak could last just a few months, as it happened in 2020 when the markets saw an uptrend after a crash in March 2020; or it could undergo a correction that lasts years.
Increasing cash allocation as an investment strategy
Cash as an investment asset serves two purposes—it acts as a hedge against financial hardships, such as a sudden medical emergency or a job loss. It also provides the opportunity to make favourable investments as they come up. In anticipation of market correction after an apparent peak, investors sell their equity securities to use the money for fresh investments when prices fall during the market correction. But the operative word here is ‘apparent.’ As mentioned earlier, it is only on looking back that a market peak can be accurately identified.
Let’s consider a hypothetical situation. Suppose you have invested in equity mutual funds, which have been giving you great returns. But you choose to redeem or close those funds during an apparent market peak. However, you were mistaken, and the market continues on an upward trajectory for another 8–9 months. Your decision to cash out has resulted in a tremendous loss of growth opportunity on your equity mutual funds. An opportunity cost is termed as the loss of potential benefits when you choose one alternative over another. Here, the return you have missed out on is the opportunity cost of cashing out on your equity investments.
What you should do
It seems pretty clear that timing the market does not work. So, what does? When it comes to investing in mutual funds, being disciplined and systematic in your investing, and remaining invested is the key to success. This is especially true for equity mutual funds. To make the most out of your mutual fund portfolio, consider taking the following steps:
1. Have a long-term horizon:
Ideal investment shall be for a period of 7-10 years to get the most out of your mutual fund returns. However, in terms of short-term goals, one should stay invested for a period of 3-5 years.
2. Use a Systematic Investment Plan (SIP):
An SIP can be beneficial in all market phases. It will buy and accumulate more units during a bear market phase while buying fewer units during a bull market phase, which might help optimise the returns.
3. Periodically reassess and rebalance your mutual fund portfolio:
During bull market phases, your portfolio could be heavily skewed toward equity investments. But you must keep a check that there is some debt investment to balance it out. This is especially required if you don’t have a large risk appetite. You must ensure that your portfolio accurately reflects your current risk appetite.
4. Diversify:
Try to diversify your mutual fund portfolio across asset classes, market capitalisations, and risk potential. This will ensure that when one type of mutual fund does not do well, there is at least one other type that is acting as a buffer for your portfolio.
5. Set goals:
Using a goal planner and having a separate investment portfolio is a healthy way to achieve future financial goals. Such a strategy will help you make the right mutual fund investments for each goal and time horizon.
Summing up
A market peak does not necessitate the need for making a lot of changes to your mutual fund portfolio. Do not let the market peaks and bottoms bother you. Rather, stay invested for the long-term with an eye on your financial goals.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.
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