A reader says, “I get the rebalancing and how the backtests prove how it works for most market conditions. But what about the quality of the assets we have chosen for investment?”
“For example, if an Adani like situation arises for a fund house? How do we handle that? Well, one may say we must diversify. But how much diversification is enough? For example, I already have four MFs selected with the help of your trackers.”
“But I am not sure why four and why not three or five or anything else. Then again, we may not have an Adani like situation, but something else to impact a scheme. For example, the Parag Parikh Flexicap could not invest in foreign companies due to a sudden change brought about by the regulator.”
“Now, what do we do when such a thing happens? What should be the framework of thinking and analysis here? If you could share some ideas here. I am looking for a way to think through this instead of a point solution. That’s all.”
Here are some ways to address this.
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- Appreciate that this can never be prevented.
- All we can do is soften the blow with “some” diversification.
- Understand that portfolio management is all about playing it by ear, and there is no place for regret (that it affected us) or relief (that it did not affect us) in the stock market. Both represent hindsight bias which is useless for the future.
- Never chase after performance. What goes up will come down after we start investing in it.
- Always look for mutual funds or stocks that never captures anyone attention. Their performance is reasonably consistent but never spectacular. Or better yet, settle for an index fund.
- Replace greed with reasonable expectations.
The diversification part is us being proactive and the playing it by ear, reactive. But how much diversificaton is sufficient? There is no formula for this, as it is quite subjective. Some have just one fund and call that a diversified portfolio; some hold 25 funds and call that diversification.
Just hold the funds you think are reasonable and can sleep peacefully. If you escape a crisis, attribute it to luck. If you get caught, dust yourself off and move on.
You said, “I am looking for a way to think through this instead of a point solution”. I appreciate this as there is no point solution.
We must appreciate that there is not set formula in portfolio management. The basics like asset allocation, diversification, rebalancing etc., are well established, but these are only thumb rules. Once we start the investing journey, we must course correct according to the obstacles we face.