How can you handle market volatility, better?
When the market is rising, everyone is happy. When the market turns down, everyone panics. There are ways you can tactically, manage equity volatility.
If your investment experience is good, you will continue to invest else you would prefer safer options say a fixed deposit. We never want to see the value of funds going down, especially over the long-term.
Here is the strategy you can use to reduce equity volatility. When the market is zooming, the portfolio will increase less than the market, and when the market is falling, the portfolio will not fall that much.
Think of a strategy when the equity market is down, you invest in equity and when equity is expensive, you invest in bonds.
There are two buckets, short-term debt and Nifty500. Nifty500 represents equity and can be substituted by a combination of mutual funds.
How can you understand when the market is expensive and when the market is cheap? by understanding the price to earnings ratio of NSE500.
And how do you understand when bonds are expensive or cheap? by understanding yield 10-year government bond yield curve.
Factor = 1 / PE + Dividend yield (1.57%) – 10 year government bond yield
If the factor value is positive invest 75% equity or else 25% equity. The rest stays in short-term debt fund.
This way you will be able to generate a return that is less volatile than the general market movement. Since you will reduce the volatility, achieving a 10% p.a. return over 5 years is quite achievable.
This is a conservative asset allocation strategy than a 100% allocation in equity. There are periods when the market crashes drastically, and this strategy will look extremely attractive. However, long-term return profile will be more favoring equity allocation for long-term, say 10-year plus.
This strategy helps in addressing the behavioral aspect because of downside protection.