How to stress test your investment portfolio with 3 simple questions

Learn simple steps to test your personal investment portfolio for stress and take corrective actions to ensure financial preparedness. While the stress tests conducted by AMCs may be complex, as individual investors, we should also undertake simple steps to test our personal portfolios for stress and take corrective actions if needed so that we are well-prepared for any financially stressful situation.

Small and midcap funds have been in the news in recent months as the capital market regulator made it mandatory for all the (AMCs) to disclose portfolio results for their small and midcap funds. Such stress tests are supposed to help assess funds’ ability to meet potential redemption pressure, especially from large investors in a stressed market environment. The disclosures are aimed at making investors aware of the , especially given the surge in assets managed by such funds at a time when valuations of small and mid cap stocks seemed expensive. While many AMCs have been conducting such portfolio stress tests regularly for their internal , they have now started disclosing the results of these stress tests in line with the regulatory requirement. This stress test data is expected to help investors understand the liquidity profile and other risks in the small and midcap funds they have invested in or intend to invest in.

Now that was about the portfolios managed by the AMCs. But what if I ask you - Have you carried out stress tests for your personal ? Well, the stress tests of AMCs may be a little complex, but as individual investors, we should be aware of some simple steps to stress test our personal portfolios and take corrective measures, if necessary so that we are well prepared to face any financially stressful situation.

Here are three simple questions you can ask yourself to stress test your personal investment portfolio

Do I have enough savings for personal financial emergencies?
Unplanned expenses or financial emergencies can arise any time and hence it is of utmost importance to set aside some money to meet such financial needs. Typically setting aside an amount equivalent to approx 3-6 months of your expenses is considered ideal for such needs. It is best to park such money in highly liquid, safe and least volatile investment instruments such as liquid funds or short term debt mutual funds, bank fixed deposits, etc. If you don’t set aside money for such financial emergencies, it may force you to make an untimely exit from some of the other long-term investments, if any financial emergencies arise in the future, which may not be the best thing to do.

Will I be able to meet my cash flow needs for short term financial goals, especially in a stressed market environment?
Most of us have some financial requirements or goals that are near term in nature, say within the next three years. This could be for making a down payment towards the purchase of a house or a car, paying for your kid’s school fee, paying for a holiday, etc. One common mistake many investors make is to invest such money meant for short term financial goals in riskier or volatile asset classes. Withdrawing money from such an asset class can become tricky, especially when the prices of that asset class are depressed. For such , it’s therefore best to maintain exposure to high credit quality fixed income instruments such as short term debt funds, short term government bonds, corporate bonds, etc. These investments typically yield a reasonable return with relatively low volatility and hence suitable to address such requirements. It is however, important to match the maturity of such investments with your cash flow requirement to reduce interest rate risk and liquidity risk. Some of these instruments are also tax efficient compared to traditional products such as fixed deposits.