Come Diwali, and one of the rituals associated with it (along with shopping 🛍️, firecrackers 🎇 & delicious sweets 🍨) is – mandatory cleaning up of the house 🧹. It involves:
- Dusting, removing cobwebs, deep cleaning etc.
- Getting rid of things no longer of utility – like clothes you’re no longer wearing (either because you’ve become too big for them or the other way round!), gadgets no longer being used etc.
- Rearranging your wardrobe – for you to become more organized, access stuff faster, etc
Now, before you start wondering why this discourse on something as mundane as saaf safai (were you doing just that before this message distracted you? 😉), let me come to the point.
Just like we do this annual Diwali cleaning exercise in our households, it’s extremely critical that we do something similar with our personal finances & investments 💰💹as well.
Why do I say this is extremely critical? Hold your horses & just read along…
1. Just being on top of things: in the rush of our busy lives, we lose sight of the bigger picture because our investments are spread across so much – we have mutual funds, stocks, EPF, NPS, PPF, FDs, gold in whatever form, crypto, real estate etc. Just having a single view of your investments is a starting point for critical decisions like how much returns you are earning on your portfolio, what’s your asset allocation looking like, etc.
2. Removing redundancies: just like most of us keep only adding new & shiny things to our wardrobe without reflecting on how we intend to get rid of the old stuff, we have similar approach towards our investments as well. It is common to come across individuals with 25-30 or even more 😲number of schemes in their mutual fund portfolio or to see 4-5 schemes from within the same category of mutual funds. But why am I raising alarm on this? Because the more clutter in our portfolios, the less are chances of we having the bandwidth to actively monitor each & every one of them. “Out of sight, out of mind” as they say.
3. Optimize the returns: chances are that we’ve been adding more schemes to our portfolio basis recent returns. And over a period of time, if we do that without getting rid of the consistent under performers, we become a mutual fund collector! Pretty much like a wardrobe which sees only inflows, and no outflows.
The biggest danger in doing this is – our returns are sub optimal because many of the accumulated schemes have started performing poorly. And if proactive actions are not taken to get rid of them, there are serious chances of we not meeting those goals for which we have invested in the first place.
4. Getting our asset allocation right: we worry a lot about “which are the best schemes”. However, what matters more is – is our asset allocation in line with our goals, our risk appetite & the time in hand to achieve those goals? This annual exercise is a great opportunity to sync all these together.
Now that we know why this exercise is so important, lets put some thought to the kind of questions we need to be asking ourselves while doing this exercise. To my mind, these are the MUST HAVE list of questions we should address:
A. Are there any changes to my financial goals in the last 6-12 months, basis what’s happening in my career & life events? If some new goals have come up, do I have a plan to fund that goal?
B. Given my financial goals, is my asset allocation optimal or do I need to change something to give my best shot at achieving those goals? This is a good time to reassess if my money is working hard enough.
C. Have I diversified well enough across asset classes like equity, debt, gold, real estate or have I unknowingly taken on too much exposure in one asset class? Not just asset classes, one needs to look at effective diversification across – different fund houses, different market caps (large cap, mid cap, small cap) & different investing styles (growth, momentum, value, low volatility, etc). Many portfolios I have seen recently have a very high tilt towards mid & small caps or themes like defence, PSUs, manufacturing etc. Our decisions are very often influenced by recency bias & one needs to watch out for risks of over concentration.
D. Do I need to rebalance my portfolio because recent movements in the market have turned it out of sync with my risk tolerance & targeted asset allocation? For instance, if you have decided on a 60:40 for the equity versus fixed income components of your portfolio for now (this should be dynamic), but the recent run up in the markets has skewed that to 75:25, this is an opportunity to rebalance by booking some profits.
E. How are the performances of individual mutual fund schemes in my portfolio vis-à-vis their respective category benchmarks? Am I holding some schemes which are consistently lagging behind their benchmarks? May be time to replace them. But do not construe this to mean that one should constantly be on the trigger to exit from one scheme to another basis very limited number of recent data points.
F. Have there been any changes in the taxation environment as a result of which I need to rejig your portfolio?
Hope you found this useful & you got some food for thought on why annual financial review is so important. Please feel free to reach out if you have any doubts or questions around this.
And before you pick up the dusting cloth & liquid spray again, I want to wish you and your loved ones a very happy, healthy, peaceful & prosperous Diwali🪔. Thanks for your time.
