Asset allocation answers investing dilemmas
To craft an asset-allocation plan, it is tempting to go by Western thumb rules; however, it is best not to apply such rules blindly; there is no single thumb rule that works for everyone
ith gold prices shooting up recently and the stock markets entering a volatile phase, investors have been writing in with many questions. Should they be selling their shares to lock into pro ts? Should they buy gold though it is at a lifetime high? Should rsttime investors go for equity funds or stick to xed deposits? Asset allocation provides easy answers to most of these questions.
WWhy asset allocation
Starting your investment journey with an asset allocation plan can lead to better return outcomes in three ways. One, it ensures your portfolio matches your risk appetite. If you are an investor who will spend sleepless nights about a 20% decline in your portfolio value, then you obviously shouldn’t be allocating 100% of your portfolio to equity funds where 30% draw-downs are not ruled out. With a portfolio split equally between equity and debt, you can ensure that your overall portfolio dips only by 15% even if the stock market crashes by 30%.
Two, it helps you avoid the emotional roller-coaster. Usually, investors load up on an asset when its price is rising and shy away from it when prices are fall
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ing. This is the opposite of ‘buy low, sell high.’ Asset allocation nudges you to sell a rising asset and add a falling one, helping your long-term returns.
Three, it prompts you to own a diversi ed portfolio at all times. One of the big temptations that investors are prone to, is chasing assets that have delivered great performance in the recent past and ignoring those that are out-of-favour. Working to a xed asset allocation plan prevents us from such behaviour. So, if the above points have made it clear why you need an asset-allocation plan, how do you go about drawing up such a plan? Here are a few tips.
Factors to consider
To craft an asset allocation plan, it is tempting to go by Western thumb rules such as “Park 100 minus your age in equities”.
But it is best not to apply such rules blindly if you want to succeed at asset allocation.
There is no single asset allocation thumb rule that will work for everyone. You should decide on your asset allocation based on the following factors.
Your age
The younger you are, the higher the allocation you can aord to have in risky assets such as equities. This is because younger investors have the ability to stay invested through draw-downs in portfolio value and wait for prices to rebound in the next cycle before withdrawing from their investments.
Older investors may not have this luxury.
Waiting period
In India, stock market cycles usually last 6-7 years from one peak to another. Therefore, if you end up investing in equities at a market high (which is evident only in hindsight), you may need to endure a 6-7 year wait for your portfolio value to return to even keel. This makes equities unsuitable for nancial goals coming up in less than 6-7 years, as you may be forced to withdraw in unfavourable markets. For such goals, you should use debtheavy portfolios rather than equity-heavy ones.
If you have signi cant liabilities or loans to service, you may not be able to stomach big swings in your net worth. This reduces your ability to take risks and thus argues for a lower equity allocation in your portfolio.
With a portfolio split equally between equity and debt, you can ensure that your overall portfolio dips only by
15% even if the stock market crashes by 30%.
If you have many dependents to take care of and need to withdraw from investments often, you should have higher allocation to safer assets such as debt
Your family situation
If you have many dependents to take care of and may need to withdraw from your investments often, you should have a higher allocation to safer assets such as debt rather than volatile assets such as equities.
Your liquidity needs
Some assets can be liquidated at short notice while others cannot. Usually nancial assets such as stocks, bonds, mutual funds and xed deposits can be liquidated quickly.
Time is essence
Whereas physical assets such as real estate or gold take a long time to be liquidated or can be liquidated only after a signi cant sacri ce on the price. In your asset allocation, make sure to have a mix of illiquid and liquid assets based on your requirement.
Your risk appetite
Irrespective of age, some investors have a lower ability to take on risks than the others.
Some people cannot tolerate even a 10% uctuation in their investment value. Others can easily survive 50% draw-downs. Therefore, gauge your risk appetite, your ability to take losses and then decide on your asset allocation.