Investors’ behavioral biases and industry’s unethical practices lead to portfolio disorders. These disorders lead to the creation of a sub-optimal portfolio. This, in turn, limits the portfolio’s performance. The investor does not realize the impact in the short term, but in the long term, this leads to investors’ dissonance when the investor understands the massive difference between the wealth created by his/her portfolio and what could have been created, had portfolio been optimal.
Your portfolio is also a victim to one or all of these portfolio disorders and following are the reasons for its under-performance
1.FIXED DEPOSIT DISORDER
This type of portfolio disorder is present in more than 90% of investors’ portfolios. Their portfolios comprise of FD and FD-type of assets owing to investors’ lack of understanding and risk-averse nature. Even if you have one rupee lying in FDs, your portfolio is a victim of this disorder. What most do not realize is, this disorder destroys the portfolios’ returns and over a period of time it reduces wealth in terms of purchasing power as FD return doesn’t even beat inflation. There is no reason to lose to this disorder as there are safe debt funds available having better returns, better liquidity, and better tax efficiency. Also, one must understand the time horizon and risk factors while investing for the long term.
2.ASSET ALLOCATION DISORDER
This disorder is also present in most investors’ portfolios as most portfolios are sub-optimally created. Portfolios are either too risk-averse or too risk prone. Also, asset allocation follows a trend. More equity allocations are made when markets are high & rising; more debt allocations are made when markets are low and correcting. This disorder is avoidable with a better understanding of when and why one must invest in equity and when to stay away.
A simple rule to follow is, “if the horizon is more than 10 years, equity is the best investment and must be adopted confidently. However, one must be cognizant of valuations while doing any lump sum investments when markets are expensive. At expensive valuations, one must practice caution and follow systematic investing. Debt investments are important as these act as speed breakers and helps in portfolio re-balancing apart from fulfilling the liquidity needs for short term goals. Like a portfolio that is skewed towards debt is not the optimal allocation. Similarly, a portfolio which is 100% skewed towards equity is also not the best and optimal – it’s like driving a car without breaks!
3.OVER DIVERSIFICATION DISORDER
This is the most common disorder present in every second mutual fund portfolio. As investors like to keep all types of flavors in the name of diversification. Like there is a saying that “Excess of everything is bad” so is over-diversification. Good and consistent performance is rare and not easy to achieve.
4.INVESTMENT EXPENSE DISORDER
This is another portfolio disorder, rather an evil one that could be very harmful to the portfolio. Especially if the portfolio comprises of expensive funds that are added without proper research and with the motivation of high commissions. The hidden commissions may be bad in terms of cost, is worse in terms of bad advice. Bad advice leads to bad decisions which create a permanent loss.
5.PRODUCT SELECTION DISORDER
This is not as common as other disorders but is prevalent in form of lock-in products in some portfolios. The market is flooded with hundreds of good as well as bad products. One bad product spoils the portfolio returns especially if the allocation to a bad product is high. So, scouting the market and careful selection of the right product is very crucial to better performance.
Since you know 5 common types of portfolio disorders, now you can make an informed decision.
Disclaimer: Investments are subject to market risk. This write up is issued by PMS-AIF and is produced for information purposes only. Information and opinion contained in this document are published only for the assistance of the recipient. It is neither a solicitation to sell nor shall it form the basis. Or be relied upon in connection with any contract or commitment whatsoever or be taken as investment advice.