5 rules for a smart investment strategy

Financial priorities change over one's lifetime. But the principles that make for a good plan stay consistent. Here are five suggestions on how to have a smart investment strategy.

1) Avoid cookie cutter solutions to your asset allocation.

Once you get the broad principles in place, fine tune it to suit yourself. For instance, equity is a must to defend your portfolio against inflation and build wealth. But how you apply it will depend on your personal situation.

Take two individuals in their thirties earning the same salary. One has a number of dependents and is saving for the downpayment of a home two years down the road. The other has no dependents and no siblings, lives with his parents in a huge house, and has no intention of moving out. Naturally, the latter’s equity allocation would be much higher despite both being the same age and earning the identical salary.

Don’t blindly follow the age rule for equity and debt allocation. Take your risk profile and your investment goals into account. If you are saving for retirement, the equity allocation would be much higher than if you were saving for a home to be bought in the next few years.

2) Tips are for waiters, not investors.

Cynicism isn't a particularly positive attribute, but it has its place. Be cynical of tips when it comes to investing. In fact, it makes sense to avoid them altogether. When investing in stocks, you need to make an informed decision. Besides tips, avoid hunches and speculation. Don’t risk gambling away your savings.

To be a successful stock market investor, you need to think and behave like an owner. If you are buying businesses, it makes sense to act like a business owner. This means reading and analysing financial statements on a regular basis, weighing the competitive strengths of businesses, as well as having conviction and not acting impulsively.

It also means you have to pay wisely for quality. The difference between a great company and a great investment is the price you pay. Always have a margin of safety built in to any stock purchase you may make.

3) Don’t go overboard with too many funds.

We are not against diversification, but don’t misunderstand the concept. Diversification does not mean you become a fund collector. It is not about the quantity of holdings but how well they balance each other out. Good funds combined in the wrong way can make a bad portfolio. Use our Instant X-ray tool and you may be surprised at the overlap within your portfolio.

Avoid buying all the schemes from one single fund house. Never cast your lot with just one type of investment or one type of fund. Spread your investments across assets, regions, sectors, and investment styles. One year’s ‘hot topic’ can become the next year’s dud. Anyone invested fully in one area takes the risk of watching their portfolio swing violently between notable gains and substantial losses.

4) Start now.

Procrastination is a bad trait in itself, but can be disastrous when it comes to investing. Procrastinate on your diet if you need to (not that we are suggesting it). But don’t delay on your savings plan. The longer you wait, the more it works against you. Compounding is a mathematical computation that works with time on its side.

Don’t wait for your next bonus to invest. Also, as your salary or income increases, let the allocation to investments also rise. The more you delay, the more it reduces the amount of time your money has to work for you. If you had invested Rs 2,000 per year over a decade, the value of your investments at the end of the time period would be far greater than had you started investing Rs 4,000 per year halfway through that period.

5) Don’t trade on the headlines.

Staying focused on your goals and investments. Don’t let your emotions and those of the crowd carry you away. Markets will rise and fall and stay volatile. Don’t try to ride those waves. Stay systematic and methodical with your investments. Avoid churning needlessly.

It’s difficult to ignore your emotions completely but the statistics prove that stock performances over time tend to improve and come back. So one must stay the course.

As Charles Ellis, the legend amongst index fund managers, stated when on the subject of investors’ emotions. “When you feel euphoric, you are probably in for a bruising. When you feel down, remember that it is darkest just before dawn and take no action. Activity in investing is almost always in surplus.”

The key message here is threefold: taking a long-term view is important because it reduces the impact of volatility; trying to time the market leads to slip-ups; and diversification is very helpful for spreading risk.

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