Most investors would answer this question with a resounding YES! And why not. Things have not looked so good for the stock markets in years. The monsoons have been good and results from corporates too seem to indicate that the overall environment is favourable for higher economic growth. Disinvestment of public sector companies has been happening at a steady pace. The reforms process is on (electricity, investment rules etc.). And on top of all this, the global environment is such that India is emerging as a favoured destination for investors.

As always the investment argument is not complete without bringing to the fore some of the concerns that could derail this what-seems-to-be the rally. But before we list out some of the concerns, which will probably help temper your expectations of returns from the stock markets, let's revisit the risk  return tradeoff.

Investing in stocks, though more risky, has its advantages. Indeed, most portfolios must have exposure to this asset class (To know more, read Equities: The time has come). But, and this is important, the exposure to equities must be determined keeping your risk profile in mind. So if you are about to retire in 2 years, and have no one to support you post retirement, it would be wise to sacrifice almost entirely the attractive returns and settle for low risk instruments (see graph below). This is just one example. Simply put, your risk profile does not change if today the stock markets start to rally. Therefore the case for suddenly deciding to invest in equities, even though your risk profile does not permit you to, does not hold.

Now some of the concerns that are probably being overlooked by investors when investing in equities.

First, there are elections around the corner, both in the centre and some states. History suggests that political parties, keen to curry favour with the masses, rake up issues and take decisions which may not be in the long term interest of the economy. Not surprisingly, in the last few days, announcements, which have generated some concern, have been made.

Second, the state of the government's fiscal situation is still alarming, even though chances of a fiscal collapse are negligible. A persistently weak fiscal situation will continue to stymie prospects of a jump to a higher growth trajectory for the Indian economy.

Third, on a technical note, the stock markets have already rallied by about 30% in the last couple of months. To expect them to continue to rally at the same pace would be wishful thinking. Smart investors would probably be booking profits now and switching to more diversified equity funds, to ensure that they do not deviate from their pre-decided asset allocation (more of that later).

Are we saying that one should avoid equities in these times? No. We are suggesting that such a decision be governed by not just the attractiveness of the stock markets (from the long term perspective) but also by the overall asset allocation plan that you have designed for yourself, keeping in mind your risk profile.

The stock markets surely look attractive from a long term perspective. And, as we have discussed in the past,a well diversified portfolio, which suits your risk profile, tends to minimise losses in case things were to go drastically wrong (for example the TMT meltdown).

So what should you do now?

Revisit your asset allocation plan and ensure that you stick to the same. It is as important for you to cut down your exposure to the equity markets in case you are over weight, as it is to the debt markets (which too can be volatile at times). Also ensure that you do not get carried away by super profits earned by your neighbour in recent months i.e. let not greed rule you again.

As someone rightly said  it is very important for you to keep your head when all others around you are losing theirs!

 

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