Equity - How it fits into your investment portfolio.
Debt brings stability and predictability to your portfolio. Then why do we need to have equities in the portfolio? Equity is all about long term returns. When you buy equities you become part owner of the company and have a say in its decision making. When companies perform well or when they disrupt markets, it is equity that sees maximum accretion in value. Of course, if you don’t want to get into equities directly then you can go via the mutual fund's route. The moral of the story is that equities create wealth over the long term, although they add to the volatility in the short term. Portfolio investments are about creating wealth in the long run and your investment strategy has to be built on that. Whether you invest in direct equities or in diversified mutual funds, there is the logic of wealth creation to equities. Let us see a few ways in which equities fit into your overall portfolio.
Ways in which equities impact your overall portfolio
1. Equity portfolios have a longevity advantage. It refers to the ability of the portfolio to weather many a storm and cycles. It is not about having the most profitable portfolio but it is about creating and managing your stock portfolio such that is able to survive over a longer time period and also performing better than the benchmarks.
2. Equities help to participate in the overall growth of the company and the industry and that can be very profitable in the case of industries companies. As earnings grow and P/E Ratios expand, it is equities that benefit the most.
3. Equity risk can be reduced by diversifying across risk classes. The overall portfolio has to be well diversified to be effective in the long run. That means the equity portfolio must be spread among different sectors and themes so that the risk is reduced.
4. Stocks typically go through cycles of popularity, high returns and also of low returns. Investors can use an opportunity component of the portfolio to tap upswing and downswing cycles and opportunities. Thus you can act within an overall passive strategy.
5. Equities allow an investor to spread their positions depending on time perspective. For example, trade can be intraday; trade maybe for a month or investment for a few years. An investor can also adopt a more passive approach and just invest money in an index fund or an index ETF. Even diversified mutual funds give you the benefit of spreading your positions and pick and choose the theme you want to invest in.
6. Equities can help you beat the vagaries of the market by adopting a systematic approach. That way you spread your investments over a period of time and also get the benefit of rupee cost averaging.
7. Equity can be easily rebalanced after monitoring. What does that mean? Some basic checks are called for. Is the portfolio in tune with your long term goals? Is a set of companies in the portfolio consistently underperforming? Is there is a structural shift or new competition that is emerging in some stocks that you are holding? Once we monitor, these we can take a call on whether we want to maintain the status quo or rebalance the portfolio. Regular monitoring instills the disciplined take a zero-base approach to stocks on a regular basis.
8. Equities can create alpha by allowing you to participate in the long term greatness of stocks. Great companies have survived over the years by their strong brands and corporate governance standards.
Quite often, we look at equities as a high-risk game in search of high returns. That is not just what equities are about. In fact, equities are so dynamic and flexible that you can also use equities to actually reduce your portfolio risk. But more importantly, it is equities that generate the much-needed alpha to create wealth over the long run.