While investing in stocks, bonds and mutual funds, past performance becomes a strong input in making investment decisions. Question, should keep on relying on it excessively or there are other indicators available to investors, on which they can rely on to make investment decisions.
While looking at past performance look at the future too…
However, for a lay investor, it will not be easy, as the famous economist, John Keynes had said, in the long run we are dead. As investment in stocks and mutual funds are normally long term, investors may use this indicator too to support their past performance data.
Past Performance is one of the factors to be considered before taking the investment decision and past performance is not the only factor to be considered. Are you relying mainly or only on the past performance? It is like looking at the rear view mirror and driving. You are headed towards a fatal accident.
What are all the other factors to be considered before looking at the past performance?
Diversify your portfolio…
There is an old saying. Never put all your eggs in one basket. In today’s risk management language it is called concentration risk. In fact in banks, concentration risk is considered one of the most important credit risk factors for the bank. Reserve Bank of India, as a policy measure, have recommended banks to strictly follow exposure norms, i.e., not to lend a borrower or a group of borrower or in a particular industry or business or financial instrument or geographical location beyond a certain percentage of the capital of the bank.
Investors may take an important lesson from this guidance of the Reserve Bank while deciding on the composition of their investment portfolio. To spread the investment in to different segments of business, industry, types of instruments, and then may invest.
Have a judicious mix of equity, debt and precious metal in your portfolio…
If you are less than 40 years, you may have a mix of portfolio, where equity would be say 50%, Debt 30% precious metals and other investment 20%. As you advance in age the equity portion will reduce and others should increase. In India, the returns on equities in the last 40 years have outstripped far higher compared to all other investment options. But, please remember, return on equity should be always expected in the long run.
Factor in time diversification…
Market or business cycles vary from industry to industry, business to business. Also business cycles should be also factored in to for long term.. Longer the time period we take and more businesses or industries we diversify, the peaks and lows of business cycle even out.
Investors would definitely argue, if we only invest in the long run, what about short term fund requirements. For short term investment bank FDs, and income funds are the best instruments. For income funds you may check the duration of the income funds, and match the duration of the income fund with your investment time horizon.
Say if your investment time horizon is 1 year you may choose an income fund with duration of approximately 1 year.
You need to diversify your investments across different time horizons like long term, medium term, short term, and ultra short term.
So that your portfolio will participate in different stock market cycles and interest rate cycles and generate better return by reducing the overall risk.
To neutralize the over dependence on past performance of your stocks/ bonds/ mutual funds, the above options will be helpful to give a good return on your investments while minimizing the associated risks.
(The author is Ramalingam.K an MBA (Finance) and certified financial planner. He is the Director & Chief Financial Planner of holistic investment planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He Can be reached at firstname.lastname@example.org)