Consider this: if you had stashed all your money in a fixed return instrument like a PPF in 2002, Rs 1 lakh would have grown to a princely Rs 1.47 lakh today. Now compare it to an averagely performing equity mutual fund earning 27% CAGR: Rs 1 lakh in it would have gone up to Rs 2.6 lakh, which is an incremental gain of Rs 1.23 lakh, almost double of what your fixed return investment would have grown to. And, had you diversified your portfolio to include stocks, real estate and even Ulips, analysts peg a combined annual return of over 18% in this period.
The bottom line: to keep in sync with a growing market, asset allocations not only matter, it may be the most important part of an investment strategy. So before you start focusing on individual funds or stocks, it’s crucial to design the right asset mix—one that is geared to your investment goals, time horizon and risk tolerance. Says Sanjiv Shah, executive director, Benchmark Asset Management Company: “For ease of understanding, the first thing to decide is your overall equity versus debt split. It will help you to diversify into different asset classes, namely equity, debt and cash, based on your risk tolerance and financial goals.”
We have all heard the cliche, what goes up must come down. So the practical solution is to diversify and hedge your bets. This mantra makes sense, but few know exactly what it means—and fewer still how to properly put it to work. Moreover, value of investments shift from time to time, so that an asset class that initially made up 25% of your portfolio might, over time, increase to 40%.
Taking our original example forward, if you had divided Rs 2 lakh between mutual funds and a PPFtype instrument in a 50-50 ratio, by 2007 that ratio would have changed to 64:36 ratio, without you even touching your portfolio. Which is why, it’s not enough to just arrive at the right asset mix.
You have to constantly monitor it, factoring in changing market conditions. Should you have a low-risk appetite, you will have to either increase your investment in the PPF-type instruments or cut down on the mutual fund pool and reallocate funds to this pool till you balance the ratio again.
There are a number of ways to arrive at the optimum amount to invest, either directly or indirectly, in equities. The thumb rule is to subtract your age from 100 for a man and 107 for a woman. The result you arrive at is the percentage you need to park into equities—that is, if you are in your 30s, about 70% of your investible surplus should go into equities. As you move towards retirement, your asset-mix will change too, giving more priority to liquid funds and near cash, or fixed return instruments.
For most investors, the hardest part of asset allocations isn’t choosing the right mix but sticking with it through a bull and bear run. Think about how many investors lost money by blindly getting into equities at the height of the tech boom in 1999-2000.
“You will want to resist the temptation to overhaul your mix at every market turn. aBut do rebalance your portfolio if your allocations have gotten out of what you set out by, say, 10-15%,” advises Shah. A benefit of rebalancing is that, if followed, it forces you to buy low (when you enter) and sell high (when you exit).
Financial planners suggest that it’s enough to review and reallocate your portfolio once a year. Others suggest that you can ignore imbalances unless the value of any asset class exceeds the allocation you originally selected by 15% or more. But in both cases you have to monitor your portfolio regularly.
Intellectually we all know to buy low and sell high. In reality, we rarely do this. The stock market is the only industry where we buy more when the prices rise and we don’t want to buy when there’s a sale. This may also mean taking a tough call right now, when the markets have been only going up. But your discipline will pay off over the long run, as is the case with equity as an asset class. Likewise getting into fixed return instruments and guaranteed return products are a good hedge to keep your portfolio mix in a healthy balance.
Finally, the biggest argument for asset reallocation is that it also helps you reposition investments to make the most of tax benefits.
How Balaji did it
It’s hard to imagine being able to chuckle after sacrificing Rs 1 lakh in the stock market, but S. Balaji is nothing if not a good sport. “I entered the market right as the tech stocks were peaking,” he says.“They shot up one day to fall another; and I bought into them being a techie myself,” he says.
That was six years ago, when a gangly Balaji entered the market assuming it to be as easy as writing a software code, his forte. “But I learned a lot,” he explains.And with his wife, now also an investor, he makes it a point to be more guarded.“To diversify out of my only holdings—Infosys—I parked funds from the Esops I got with a portfolio management service provider,” he says.
What began as uncorking value today from a single asset and single stock is a portfolio that would turn many green with envy. “I have hedged my bets across all asset classes—mutual funds, land, flat, diversified stock holdings, Ulips and now even my own business venture, if I can call that diversification,” laughs off Balaji.
Having quit a regular job, this budding entrepreneur is now taking control of his finances as well as he handles his business interest.“With each multiplying investment choice, I am convinced that one needs to understand one’s portfolio and risk tolerance for wealth creation.” So speaks one successful businessman in the making.
