Planning an investment portfolio is not easy, especially, when we are witnessing inflation and living in anticipation of an impending recession. Many families are already living in a financially precarious state; their condition being aggravated by the possibility of facing recession too. It is not easy to tackle the dual impact of inflation and recession together. Circumstances like these force us to look at our investment portfolios and gauge if we have planned enough to meet both our short-term and long-term financial needs.
4 points to build a recession-proof portfolio that stays ahead of inflation
The threat of recession is real, especially, at a time when all countries are raising their benchmark interest rates to combat inflation. Deepali Sen, Founder partner, Srujan Financial Services LLP says, “You must plan a portfolio across asset classes keeping in mind the future needs and goals. Overall, we need to have five to seven per cent in gold ETFs, and around eight to 10 per cent of equity exposure in international funds (across emerging markets and the USA)."
“Besides, around six to seven months’ worth of expenses for an emergency fund should be parked in a liquid mutual fund. While the objective is to be ahead of inflation (returns wise) after tax, the key driver of allocation is the goals you are planning for. So for goals needing money in less than two years, park in short-dated debt funds, for goals requiring money within two to seven years park in medium tenure debt funds and for goals after seven years, one should invest in well-diversified equity MFs (across large mid and small cap funds, targeting the mid and small cap exposure not exceeding 16-20 per cent),” she added.
Most analysts share how a well-diversified portfolio can nullify the threat of inflation and recession put together. The question that remains is, “How well diversified should a portfolio be?”
Gurmeet Chadha, Managing Partner & Chief Investment Officer, Complete Circle Wealth explains, “The golden rule is to have a return on investment more than inflation and also balance the uncertainties through a risk-adjusted approach. A nice mix of equities (earnings growth at reasonable valuations), REITs and SGBs (five to 10 per cent) can be considered. In the Indian context, whenever the 10-year bond yields have been closer to eight per cent, the next three to four year returns of bond funds have also been attractive.”
The focus must be on various investment options to ensure proper diversification across asset classes. Be it inflation or not, a well-diversified portfolio does account for unforeseen risk apart from earning from stocks and other profit-making instruments. For example, gold acts as a hedge against inflation, debt funds counter volatility, and fixed-income plans provide cash for short-term cash needs while stocks and mutual fund investments ensure returns that inflation in the long run.
Deciding on diversification
There is no thumb rule that can help you diversify your earnings into asset classes that will yield both short-term and long-term returns. With no available formula for diversification, young investors take the plunge and go deep into equity investments. These investments can be in a lump sum or through systematic investment plans (SIPs). These investments can be both in active or passive mutual funds. The notion of risk is less in young investors, which explains their increased affinity towards equities compared to other investment options.
Pratibha Girish, Founder, Finwise Personal Finance Solutions shares, “Very important to ensure that all investments are done with a goal in mind. Once this happens the time frame is clear and asset allocation becomes easier. Stick to 100 per cent debt products including fixed deposits for short-term goals (one to three years). For goals between four and six years, you can do a combination of both equity 60 per cent and debt 40 per cent. For long-term goals for seven years and more one should invest aggressively up to 75 per cent in equities. However, I do not recommend more than five per cent of the portfolio allocation to gold.”
Viral Bhatt, Founder, Money Mantra says, “Those who just starting their investment planning can with 50-50 strategy – 50 per cent in passive and 50 per cent in active funds. Once they understand the dynamics of the markets can increase active funds allocation and reduce passive gradually. Financial advisors can understand the need and concerns of their investors and suggest accordingly.”
Understanding diversification in relation to inflation
The market is in turmoil. This explains why you must shift your focus from shares and mutual funds to other investments that respond well to inflation. Many investors are rebalancing their portfolios by shifting an increased percentage of their earnings to gold. However, some argue that gold may not be the perfect hedge against the sudden surge in prices.
A look at historical data underscores how gold has outperformed Sensex only by a small margin. Not that gold prices have not increased, numbers indicate that the price of gold has gone up steadily over the past decade or so. Gold was priced at ₹31,050 per 10 grams. Currently, the price of gold is ₹51,905 for 10 grams. That is a whopping 67 per cent rise in the price of gold in a decade.
Now compare the returns from gold with the closing returns from S&P BSE Sensex in 2012 to date. In 2012-2013, S&P BSE Sensex closed at 18835.77 points. The highest level that Sensex reached this year is 60845.10. The difference shows more than 200 per cent earnings in returns, thus, explaining how consistent compounding over a prolonged period of up to a decade can garner you exceptional returns. While this justifies one’s proclivity to invest in shares, there is more to it than that meets the eye.
It would not be right to evaluate the returns from gold versus returns from the market in a consistent market situation. This is because myriad factors affect market conditions, leading to inflation or similar circumstances synonymous with an unexplained rise in prices. India experienced inflation in 2018 too similar to what we are experiencing now. The Sensex had closed at 38672.91 in 2018-19. Compared to this, the Sensex market attained 60845.10 in 2022-23 from where it cooled down to the current 53416.15. The return rate in the past decade has been barely above 38 per cent.
Gold prices in comparison jumped in 2018 and have been on a continuous growing spree to date. Compared to the linear growth rate in gold from 2012 to 2018, inflation has caused the prices of gold to grow exponentially. The price of 10 grams of gold ended at ₹31,438 in 2018 and is currently trailing at ₹52,690 for the corresponding same weight. This is a massive 67.59 per cent in the past four years under the effect of inflation. Gold is no more an emotional asset; it is a high-yield asset that can be bought in both digital and physical form depending on what suits you best. You can invest in it by buying sovereign gold bonds (SGBs) or by parking money in gold exchange-traded funds or gold mutual funds.
How to decide on asset allocation?
Deciding on asset allocation based on historical data may not be the ideal way, though you may use it to diversify your investments. Allocating a greater percentage of your earnings to investments that respond more quickly and vehemently to inflation will yield you higher returns though the ideal proportion has more to do with investors’ financial goals and investment tenure.
However, if your investment horizon ranges for a decade and beyond, the stock market may the ideal vehicle to park your earnings. Domestic retail investors have realized that both equities and gold are asset classes that are here to stay. Choosing one over the other would be futile. Instead, a decent allocation to both can help you create wealth while nullifying the dual effect of both inflation and recession in the years to come.
For a short tenure, you may stick to debt funds and bank deposits that you can liquidate within a short period to create the much-needed corpus. Turning to real estate would be futile considering how investing in this asset may either not yield the desired returns while proving to be cumbersome to sell or lease out the property to earn money when needed.
Also, it has become a fad to invest in US holdings, hoping that foreign investments will help in investment diversification. The past few years have underscored how the Indian market is comparatively more stable than its American counterparts. Also, with start-up firms and new-age companies getting listed on Indian stock exchanges, there is no dearth of opportunities for investing in the country’s markets. Foreign institutional investing can thus be avoided. Strong SIP inflows even during market downturns underline a firm belief in the Indian industries and stock markets.
Age is also a deciding factor
Those aged above 50 years must have a different and moderate outlook toward their investments. An aggressive approach unlike their younger peers may cause them to lose out on the value of their investments. This is because the sudden impact of inflation causes the stock markets to fall, thus, destroying whatever earnings they had received on their investments. Ideally, investors aged above 50 must redeem their stock investments and credit them to bank deposits or other fixed-income plans to benefit from the monthly returns. Though parking money in these plans will not beat inflation, it will surely take away the stress of losing their profits in the equities market.
Also, the bond market is relatively stable now, which means that they can park a part of their earnings in bonds that would yield them roughly eight to nine per cent interest.
Dev Ashish, Founder, Stable Investor says, “There is no one fixed, or one right, sacrosanct asset allocation based on age alone. Different people of the same age group have different requirements and goals. But generally speaking, the 50s is the time when at least the retirement portfolio of the individual should gradually transition to post-retirement allocation. This means that let’s say someone has 70 per cent equity and 30 per cent debt in retirement savings at the age of 50. Assuming that the person wants to retire around 55-60, the portfolio should be de-risked gradually. This can be done by bringing down equity to 60 per cent at age 51-52, 55 per cent in 53-54, 50 per cent in 55-56, 40 per cent in 57-58 and to 30-35 per cent equity around the age of 59-60 years."
“The idea is to protect them from a bad sequence of return risks which can wreak havoc on the portfolio. For the debt part of the portfolio, assuming that employees’ provident fund (EPF) is still there in the 50s, the money liquidated from equity to reduce allocation can come into debt funds, bonds, and NPS Tier 2 (G+C), etc,” he added.
Inflation coupled with recession can be too much to handle, especially, for those not financially adept at handling such situations. History teaches us to be careful with our finances, and invest where we can to the best of our ability while staying committed to our investments for a decade or more.
“Remember that you work hard for your money. It’s time to let the money work for you.”
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