
It therefore forms the backstop for creating and sustaining wealth creation from a financial perspective in modern times. Mastery over the fundamentals of active versus passive investment, diversification, and asset allocation can greatly empower both individual and business investors. These combine into a structure that seeks a balance of risk and return, considering market conditions and personal goals. This article looks at these strategies both from an Indian and an international perspective, highlighting best practices and common pitfalls with real-world examples.
- Active vs Passive Investment
One of the main critical choices made in the building of an investment portfolio is between active and passive modes of investment. Active investment is one in which there is a hands-on approach whereby the fund manager or investor chooses certain stocks, bonds, or other assets to try and outperform the market. The raison d’être of passive investing, in turn, lies in emulation of the return of an underlying index-which may be anything from the Nifty 50 in India all the way to the S&P 500 in the US.
Active Investment: High Reward, High Risk?
Active investing can result in high yields, but it also requires immense research, market understanding, and generally involves higher costs. For example, active management by the fund management team at Kotak tries to outperform the broader market indices in its large-cap and multi-cap funds in India. However, according to Radhika Gupta, CEO of Edelweiss Asset Management, “In a bull market, active fund managers find it very difficult to constantly beat the index because markets are always volatile and unpredictable.”
This strategy is suitable for investors who believe they can achieve returns higher than the average through market timing and the selection of securities. International investors, including Warren Buffett, have for many years fostered the advantages of “value investing”, a form of active investing that focuses on the selection of undervalued equities. However, even Buffett has said that for most investors, low-cost passive investments are the way forward, seemingly somewhat contradicting his own investment methodology by recognizing that few, if any, can regularly outperform the market.
Passive Investing: Simplicity begets Stability
For their generally long-term time frame, the risk-averse investor should find passive investing more attractive. Passive funds are cheaper, less volatile, offering steady, unexciting returns that mirror the market’s performance. Consider that index funds based on the S&P 500 have significantly outperformed most actively managed funds over the last few decades in terms of total return and cost efficiency.
According to Vanguard, a good indicator of their ever-rising popularity is that more than 40% of the US equity market is comprised of passive funds.
Passive investments remain the trend in India, for which ETFs such as Nippon India ETF Nifty BeES have won the confidence of retail investors with their low expense ratio and easy accessibility. Thus, to put it in the words of the great billionaire investor and founder of Vanguard Group John C. Bogle, “Don’t look for the needle in the haystack. Just buy the haystack!” The idea says it all across markets-aiming at a low-cost and long-term growth.
- Development of Diversification Strategy
The phrase “don’t put all your eggs in one basket” is rather a fundamental concept of investment itself. The basic process of diversification involves spreading the investments across various asset classes, sectors, and geographies to reduce risk and protect the portfolio from high market volatility.
Sector and Geographic Diversification: An Indian Example
The year 2020 coronavirus pandemic brought into focus the need for diversification to Indian investors. Even as many sectors began their downturn, technologies and pharmaceuticals have enjoyed robust growth. There are cases, such as Infosys and Sun Pharma, which have emerged as steady assets and plug losses brought about by other badly hurt sectors like travel and retail.
Geographic diversification plays a similar role globally, too. A portfolio comprising both developed markets-such as the U.S. and Europe-and emerging markets like India and Brazil-can therefore harness the various cycles of economic growth and differences in growth rates.
Diversification across asset classes
Equally important is diversification across asset classes, which includes such general asset groups within the context of portfolio construction as equities, bonds, commodities, real estates, and gold. As Ray Dalio, founder of Bridgewater Associates, the largest hedge fund in the world, has said, “You want to invest in assets that behave well under different economic environments.” His “All Weathe” portfolio, which consists of bonds, commodities, and inflation-linked assets, besides an exposure to equities, epitomizes an asset-class diversification approach that results in reasonably stable returns over time.
Gold is also considered a hedge against inflation and the risk of any particular currency, hence Indian investors generally hold the yellow metal as a hedge. The investing ETFs in gold, such as SBI Gold ETF, provide seamless diversification with gold without physically holding the metal, which is highly expensive to store and insure. Equity mutual funds, bonds, and Real Estate Investment Trusts (REIT) add layers of stability with potential growth in an Indian investor’s portfolio.
- Setting Your Asset Allocation
Asset allocation relates to a process of determining the percentage of one’s portfolio to invest among different classes of assets. This determination is, to a great extent, based on the financial goals of a particular individual or entity, their risk tolerance, and their investment horizon.
Age-Based Allocation: A Rule of 100 Minus Your Age
This could be instructed as the “100 minus age” rule, where one deducts his age from 100 to arrive at the percentage that must be held in equities. This would mean holding 70% in equities and 30% in safer investments like bonds and fixed deposits for a thirty-year-old. While simplistic, it provides a starting point, especially for novice investors.
Risk-Based Allocation: The Tailor-Made Approach
While for experienced investors, asset allocation can be further optimized with the help of risk profiling. For aggressive investors with a high-risk appetite, an overweight portfolio in equities and alternative investments such as private equity or venture capital may be favoured. At the other extreme, conservative investors will opt for a heavy component of fixed-income securities in their portfolios-such things as bonds or debt funds-by which they are able to conserve capital and earn regular income. Hybrid funds carry both equity and debt components in their net asset value, hence offering a balanced approach to asset allocation in an Indian context. Funds like the ICICI Prudential Balanced Advantage Fund allow investors to participate in the equity markets while protecting them to some degree when the markets are falling with their debt allocation. Similarly, international robo-advisors such as Betterment and Wealthfront guard against similar risk-based algorithms in determination and execution of asset allocation, thus making it more accessible and attuned to an individual’s risk level.
Conclusion: Creating a Durable, Long-Term Portfolio
The debate on active versus passive investing, diversification strategy development, and asset allocation setting are deeply interlinked features of a resilient investment plan. As gleaned from both Indian and global examples, these pillars go a long way in mitigating risk, maximizing returns, and adapting to economic cycles. Prudent investors would always go about monitoring their portfolios, re-evaluating each of the components relating to market fluctuations and, of course, personal goals. As A. Balasubramanian, the CEO of Aditya Birla Sun Life AMC, once said, “Successful investing is all about discipline and patience. The market will always reward discipline, whether in bull or bear markets.” These words shall remind one of the disciplined, long-term approach toward investment that would help one survive through both bull and bear markets. These basic strategies will be the foundation for both beginning and seasoned investors. A diversified portfolio, added with the informed decisions of an investor and a rightly allocated mix of assets, could set goals for growth while protecting wealth for the future. The mode of choice might be in active terms or in passive tone; the bottom line is one, which is building a secure financial future in this unpredictable world.
Dr. Prahlada N.B
MBBS (JJMMC), MS (PGIMER, Chandigarh).
MBA (BITS, Pilani),
Executive Programme in Strategic Management (IIM, Lucknow)
Senior Management Programme in Healthcare Management (IIM, Kozhikode)
Postgraduate Certificate in Technology Leadership and Innovation (MIT, USA)
Advanced Certificate in AI for Digital Health and Imaging Program (IISc, Bengaluru).
Senior Professor and former Head,
Department of ENT-Head & Neck Surgery, Skull Base Surgery, Cochlear Implant Surgery.
Basaveshwara Medical College & Hospital, Chitradurga, Karnataka, India.
My Vision: I don’t want to be a genius. I want to be a person with a bundle of experience.
My Mission: Help others achieve their life’s objectives in my presence or absence!
My Values: Creating value for others.
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Prahlada Sir,
Here is my take on your today's blog article :
*Wise Investing in the Stock Market: Navigating Uncertainty with Confidence*
In today's unpredictable world, investing wisely in the stock market requires a thoughtful and strategic approach. By embracing proven strategies and principles, you can optimize your returns and minimize risk.
*Passive Investing: A Low-Cost Advantage*
1. Index Funds: Track market indices (S&P 500, Nifty 50) for broad diversification.
2. ETFs (Exchange-Traded Funds): Benefit from diversified portfolios and low costs.
3. Mutual Funds: Focus on long-term growth with low-cost options.
*Diversification: Spreading Risk, Enhancing Returns*
1. Geographical Diversification: Explore international markets (US, Europe, Asia).
2. Sector Diversification: Balance investments across sectors (tech, healthcare, finance).
3. Asset Allocation: Harmonize stocks, bonds, commodities, and cash.
*Risk Management: Protecting Your Portfolio*
1. Dollar-Cost Averaging: Invest fixed amounts regularly.
2. Stop-Loss Orders: Limit potential losses.
3. Hedging: Invest in assets with negative correlations.
*Alternative Investments: Expanding Opportunities*
1. Gold: Hedge against inflation and market volatility.
2. Real Estate: Invest in REITs or real estate mutual funds.
3. Cryptocurrencies: Consider established options like Bitcoin, Ethereum.
*Long-Term Strategies: Time-Tested Wisdom*
1. Buy-and-Hold: Resist short-term market fluctuations.
2. Dividend Investing: Focus on dividend-paying stocks.
3. Growth Investing: Invest in growth-oriented companies.
*Investment Vehicles: Choosing the Right Fit*
1. 401(k), IRA, or Roth IRA: Tax-advantaged retirement accounts.
2. Brokerage Accounts: Trade individual stocks, ETFs, or mutual funds.
3. Robo-Advisors: Automated investment platforms.
*Key Principles for Investing Success*
1. Set clear financial goals.
2. Assess risk tolerance.
3. Develop a diversified portfolio.
4. Monitor and adjust periodically.
5. Avoid emotional decision-making.
*Recommended Reading*
1. "A Random Walk Down Wall Street" by Burton G. Malkiel.
2. "The Intelligent Investor" by Benjamin Graham.
3. "The Little Book of Common Sense Investing" by John C. Bogle.
*Valuable Resources*
1. Investopedia
2. The Motley Fool
3. Seeking Alpha
4. Yahoo Finance
By embracing these strategies and principles, you'll be well-equipped to navigate the unpredictable world of stock market investing with confidence.
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