How do equities actually impact my portfolio; both in terms of risk and in terms of returns?

Equity portfolios have the longevity advantage. It refers to the ability of the portfolio to weather many a storm and cycles. It is not about having the most profitable portfolio but it is about creating and managing your stock portfolio such that is able to survive over a longer time period and also performing better than the benchmarks.

Equities help you to participate in the overall growth of the company and the industry and that can be very profitable in case of industries companies. As earnings grow and P/E Ratios expand it is equities that benefit the most.

Equity risk can be reduced by diversifying across risk classes. The overall portfolio has to be well diversified to be effective in the long run. That means you must spread your equity portfolio among different sectors and themes so that your risk is reduced. Here you need to focus on a portfolio where each additional stock reduces the risk rather than substituting the risk.

The benefits of diversification can be achieved by a handful of 10-12 stocks. You don’t need to create a very bulky portfolio. A better way for a lot of retail investors would be to leave the investment decision making to fund managers by investing in diversified equity funds.

Equities can also be used for creating opportunities in the market. For example, you can play commodities through thematic funds or you can play indices through index funds and you can play sectors like banking through sectoral funds. This makes equities a lot more flexible and dynamic as a component of your overall portfolio.

Stocks typically go through cycles of popularity, high returns and also of low returns. A company like GE of the US was an outperformer for over 70 years but has been a gross underperformer in the last 10 years. In India, stocks in IT, Pharma, commodities, infrastructure, and consumer goods have gone through their upswings and downswings. You can use an opportunity component of your portfolio to tap such cycles and opportunities. Thus you can active within an overall passive strategy.

Equities allow you to spread your positions depending on your time perspective. For example, you can trade intraday; you can trade for a month or invest for a few years. You can also adopt a more passive approach and just invest your money in an index fund or an index ETF. Even diversified mutual funds give you the benefit of spreading your positions and pick and choose the theme you want to invest in.

Equities can help you beat the vagaries of the market by adopting a systematic approach. That way you spread your investments over a period of time and also get the benefit of rupee cost averaging. In fact, mutual fund SIPs are entirely based on this concept only.

Equity can be easily rebalanced after monitoring. What does that mean? Some basic checks are called for. Is your portfolio in tune with your long term goals? Are a set of companies in the portfolio consistently underperforming? Is there is a structural shift or new competition that is emerging in some stocks that you are holding. Once you monitor, you will have to take a call on whether you want to maintain status quo or rebalance the portfolio. At least, regular monitoring instils in you the discipline take a zero-base approach to your stocks on a regular basis.

Equities can create alpha by allowing you to participate in the long term greatness of stocks. Great companies like Unilever and Nestle have survived over the years by their strong brands and corporate governance standards. The more you focus on qualitative factors, the more is likely to be your portfolio quality.

Quite often, we look at equities as a high risk game in search of high returns. That is not just what equities are about. In fact, equities are so dynamic and flexible that you can also use equities to actually reduce your portfolio risk. But more importantly, it is equities that generate the much needed alpha to create wealth over the long run.