The recent situation in the stock market has left most wondering how and by what means they can make some gains; or for that matter just not incur losses and preserve their capital to the extent possible without any erosion.

With some mix and match, investors can reduce the risk and save their capital from eroding. By making some informed decisions and application of some proven investments principles that have withstood the test of good as well as not so good times in the stock market.

Let’s start with an example.

Ajay and Vijay, both in their early thirties are employed at a reputed MNC company. Both of them are active investors in the stock market, keen followers of its movements.  Their experience in the stock market and the continuous flow of information through various mediums like newspapers, internet, and television has made them aware of that equity gives the highest possible returns over the long-term. Also their experience has taught them how to go about asset allocation. Ajay and Vijay both have split their investible surplus in equity as well as debt. Both invest their surplus in a 70: 30 equity-debt ratio.

But the recent market slump has baffled even them as to what strategy they need to adopt; they are in a state of panic and do not know what to do to save their investments or at least prevent capital erosion.

Most people are aware of the fact that they need to hold their investments for the long term for better gains; but here the point - what is long term? And how do we know that this is the right time to sell or buy? I have come across people who told me that if they would have had sold their portfolio in January 2008, they would have definitely made good gains. But then, at the time there was this positivity all over with everyone expecting the BSE index to reach 25000+. And now that the markets have climbed downwards these same people are expecting the index to touch lower levels. There is no way to find as to whether the indices have reached their peak or they have bottomed out. Markets are sentiments driven. You can is no way time the market.

There is no simple way out. You need to be patient and more importantly, there is no need to keep your distance from the market. Here is another question: What should the retail investor in the present situation and till the time the markets return back to their original glory?

The answer is ‘constant mix portfolio rebalancing’ and Ajay has adopted this strategy. His financial planner suggested that this would insulate him from market turbulence while ensuring that he remains the king of good times.

So, what is constant mix portfolio rebalancing? And how does it work?

Constant mix rebalancing is where you calculate the initial proportion of each investment in the portfolio and then maintain that ratio at all times.

As investments go, equity investments give a far higher rate of return than debt investments. Debt returns are more conservative, usually pegged at 10% year-on-year. Hence, over a longish period, an equity-debt portfolio that starts off as a 70-30 split can become lopsided in the equity section’s favor.

So, you constantly rebalance your portfolio by liquidating enough of your profits from the equity section of your portfolio and transferring it into the debt side, to keep up the 70-30 split between equity and debt.

Given below are the tables that tell two tales - Vijay who started off with his 70-30 split but didn’t bother to rebalance, preferring to buy and hold. And Ajay, who did indeed rebalance his portfolio every year to keep up the 70-30 equity-debt split.

Vijay’s portfolio

Look at year 2. The equity investment grew at 30% while debt plodded on at a steady 10%. The total corpus at the end of year two was Rs. 124,000. But the equity-debt split is no longer 70-30.

So, Ajay calculates:

70% of 124000 = 86800, while his equity holdings total 91,000, an extra 4200. So, Ajay transfers this to the debt section, thus keeping the 70-30 ratio intact.

What happens when Ajay keeps doing this? In year 5, when the stock market goes to the dogs, Ajay’s losses in his equity investments are eminently minimal. But more importantly, he has managed to avoid capital erosion.

Vijay, on the other hand, sticking to his buy-and-hold policy, suffers a 34% loss on his equity capital plus huge capital erosion.

Portfolio rebalancing is vital part of investment policy. There can be no asset allocation target without the discipline to preserve that target. Buy low sell-high strategy has most of the times been advocated by experts but greedy investors always fail to follow this principle. Constant mix rebalancing is mechanism for sensible timing of index movement. Through this process the investor naturally buys low and sells high and the most important benefit is it reduces the risk to greater extent ensuring adequately diversified portfolio.

We both earn and our collective take-home is Rs. 60, 000. We have credit card dues of Rs. 51, 000 and a personal loan with ICICI of about Rs. 2.93 lakh. There are no savings at the end of each month. We would like to close the debts and go in for housing loan to purchase a flat. Please advise as to how the debts can be repayed. Is it good to take on housing loan when we have credit card expenses, personal loan due and regular monthly expenses to take care of?

In the current scenario when inflation is at its peak the middle class is going to be in the soup. They need to be aware of many ways in which they have to maintain their basic standard of living, for which people fall into the trap of debt. The most common and easily available loan to for a cash infusion with the lowest documentation is the personal loan. All loans if not taken for a purpose that is not of need it causes pain and could lead to distress.

Let’s see how an individual lands up in a debt trap:

Mr. X belongs to a middle class family with four dependants. His father is retired person. His mom and wife are not earning members of the family. Mr. X is the only bread earner for the family. He has a daughter who just started with schooling. Due to unavoidable personal responsibilities he had to take a loan of Rs.1,00,000 at 21% for one year. The EMI was Rs.9311.37. He was working with a private limited company where the pay is just so-so. His take-home pay is hand to mouth. After taking the loan, within the next three months he lost his job. He was unable to pay the EMI on time. He defaulted on his payments with the bank. After few months he got a job in a good MNC company and wanted to take on one more personal loan to repay the previous loan and come out of the defaulters list.

Since Mr. X already defaulted once, it would be difficult to fetch him a personal loan. To pay back the first debt he wants to go for a second personal loan. This would make him fall again in the debt trap. This time it would be difficult for him to come out of it.

Before taking a personal loan think that whether you genuinely require it or not. In case you have decided to go ahead for a personal loan do not just go with one bank and stick with their terms. A bank knows that a personal loan is more of an “individual’s requirement”. It is not a product which the bank needs to sell or offer it to the people. In current situations many of us are forced to perform things which we do not like, but still we have certain responsibilities to fulfill. This compel us take a personal loan to meet our current obligations or desires only. One does not even consider how much essential one’s credit-worthiness is. In future when one actually requires a personal loan it will not be easy. The bad track record would be an obstacle. It is better to find out with more banks and financial institutions with what rates they offer. Then take a call and find a best deal.

The other option is to take a secured personal loan. They have lower interest rates. The securities which lie in the lockers are of no use to us. In India we are very emotionally attached towards our possessions and we feel we can not deploy them for taking a loan. But if in case it fetches a lower rate of interest on your personal loan, then those possessions are invaluable. In India by personal we understand it is unsecured in nature. Our insurance policy, shares, investments made in National Savings Certificate, Kisan Vikas Patra etc can help you get a personal loan at a lower interest rate which other wise would be very high.

A personal loan is easy to obtain because the interest rate charged are very high. In financial markets there is nothing said as free lunch, you pay for each and every thing you want. So it is sensible to approach many banks and then go ahead with that bank which can offer you the best deal. Loan against security would be a better option. It will not give you sleepless nights.