Asset allocation involves dividing an investment portfolio among different asset categories, such as equity, debt, gold and others. By investing in more than one asset category, an investor will reduce the risk of losing money and the overall investment returns will have a smoother ride. Have you ever noticed that street vendors often sell unrelated products together; for example, umbrellas and sunglasses? When it is raining, it would be easy to sell umbrellas and sunglasses sell faster on sunny days. The same idea can be applied while making investments with the simple tool of asset allocation.
Any investor whose age is 50 years or below has a minimum 10 years for retirement. For them, an asset mix of 80% in equity and 20% in debt can be considered as an optimum asset allocation. After the investor attains the age of 50, a review of the portfolio should be done periodically and the allocation of equity should be proportionately brought down to 70% by the age of 60.
On attaining the age of 60, which is the general age of retirement, an investor should first assess how much money will be required going ahead for his/her basic needs. This money should be invested in fixed income instruments which will provide a regular income to the investor. On the balance portfolio, the investor can follow the strategy an asset mix of 70:30 in equity and debt, respectively. Depending on the risk tolerance of the investor, a deviation of 5-10% in the asset mix can also be adopted.
Let us consider an example wherein a moderate investor started investment in 2010 at the age of 50 and adopted the asset mix of 80:20.
Note: Nifty 50 returns considered for Equity & 10yrs average deposit rate of SBI considered for debt at 7.25%
The percentage of each asset in the portfolio will depend on the investor’s risk tolerance and time frame of the investment. One thing that an investor needs to keep in mind is that it is not advisable to borrow money and make investments; borrowing money will involve a cost which will reduce the returns earned from the investment. Risk tolerance is the amount of loss an investor is prepared to handle while making an investment decision. Knowing the risk tolerance level helps investors plan their portfolio and will determine how they invest.
Asset allocation is not a one-time activity, it is a continuous process. Following an asset allocation-based approach prevents an investor from getting affected by the distractions in short term and at the same time, he/she can make wise decisions and reap the benefits from opportunities provided by the market. Equity markets are volatile and hence one’s asset allocation must undergo change from time to time. When markets go up, equity exposure in the portfolio tends to rise, whereas when markets fall, equity exposure in the portfolio is reduced. It is important for the investors to determine the level of diversion that can be accepted by them.
Long term investment is generally done by investors to achieve some financial goal, be it retirement planning, child education or marriage. If investors reduce the unnecessary expenses, start saving money by investing as early as possible and religiously follow the pre-determined asset allocation strategy, then, accumulating the target money for the long-term goal will become easier.
The table below summarizes the asset allocation that can be maintained by different type of investors at various stages of life.
(The writer is the director and head of Mutual Funds vertical at Ventura Securities Ltd)