How to align your financial strategy with today’s shifting markets

You don’t need a financial expert to understand that we are currently navigating a period of economic uncertainty. The writings are on the wall: Inflation is rising at an unsustainable rate, policymakers are running out of answers, and “risk-adjusted returns” are becoming a tall order. However, it is stupefying that when we ask questions like “When was the last time you reviewed your investment portfolio?” the answer often predates the last six months. Such portfolios are often characterized by a lack of diversification and lopsided asset allocations.

The last few years have witnessed unusual changes in tax regimes, asset performances, and geopolitical correlations with financial markets. Such conditions necessitate dynamic asset allocations. We need to ask ourselves: Are my investments enabling me to achieve my short- and long-term goals? If not, are the investments active just because they made sense at the time when my risk tolerance, asset choices, and allocation strategies were different? Such questions inadvertently lead to portfolio reviews.

Review and Rebalance

A portfolio review involves periodically assessing if the investments and their returns are aligned with your evolving financial goals and risk tolerance. By assessing asset performances against multiple benchmarks, one can unearth certain patterns and consistent underperformers that are exposing you to market risks. Such insights can be used to rebalance your portfolio. For example, if you’re averse to more risks, you can consider divesting from equities and adding weight to fixed-income instruments or bullion. However, while gold prices remained rather flat in 2022, stocks of top-tier companies appreciated considerably. That is to say, dynamic allocation is advisable over formula investing that follows a prescribed theory such as 60/40 or 50/50.

Balancing Risks Through Diversification

Portfolio diversification is a tested and proven way of hedging against risks. In recent years, globalization and continued digitalization have enhanced the scope for diversification across asset classes, sectors, and geographies. Assets such as gold have an inverse correlation with equities, so they are generally advisable to hold, especially during economic doldrums. Likewise, one can deploy capital into multi-asset funds, which distribute it to several underlying asset classes, thereby inherently offering diversification. In 2022, widespread geopolitical headwinds gave commodities a boost, rendering them attractive to investors. Strategic exposure to these asset classes and periodic rebalancing can lead to an “all-weather” portfolio that characterizes resilience and risk-adjusted returns.

Inflation Calls for a Measured Response

The dynamism in the financial markets today, fuelled by inflationary concerns, does not offer much in the way of optimism. So, it calls for a measured response, especially in relation to “lifestyle inflation”—a tendency to increase spending as income increases. Typically, inflation also leads to an increase in salaries, which enables spending. However, such expenses can become unsustainable if inflationary pressures persist and outpace salary increases. It is instead advisable to limit the expenses and allocate the surplus savings into diversified asset classes. A viable way to achieve this while circumventing spending habits is to automate the investments from the source before they reach your pockets. Besides an amount worth a minimum of six months' expenses in low-risk liquid instruments, the rest can be kept invested in illiquid asset classes.

When all is said and done, though, one cannot afford to get too caught up in short-time market volatility. The ideal approach is to review and rebalance in periodic intervals while adhering to long-term goals. Remember — long-term rewards supersede short-term safety. In this regard, a notable example is the performance of many S&P 500 stocks whose values have doubled in the last five years. However, their quarter-on-quarter growths do not paint that picture. In other words, irrespective of short-term volatilities, they have grown steadily over time. Such changes happen in a continuum, so it is better not to read too much into daily ups and downs. Financial strategies should be changed in response to life changes rather than the vagaries of the market.