Diversified asset allocation best ploy, says expert

Sat, Jul 21, 2012 at 10:40

I think someone with your risk profile certainly should look at an asset allocation plan and not put all your eggs in one basket. There is a tendency of being too risk averse at a very young age. As one ages the asset allocation plan also changes. I would suggest having a well rounded diversified asset allocation plan with some money going into a house, followed by some asset allocation towards equities, fixed income securities for a regular source of income and some gold.

Also one needs to rigorously monitor how the asset allocation plan is performing at regular intervals. One of the common pitfalls that many investors tend to have is they dont have an asset allocation and even if they have an asset allocation plan they do not monitor it at all.

These issues need to be kept in mind when one is looking at investing and at a young age one can afford to take slightly higher risks than at an age group which is on the verge of retirement. Hence, an asset allocation plan of a young housewife will differ from a lady who is on the verge of retirement. From that perspective, one should look at asset allocation.
Abidi: Asset allocation is something that's very critical for all age groups and risk profiles. But Hemant they are probably at an age where not so long ago all of us were spending money on going out and clothes and all of that and now responsibilities have changed. How can investment practices then change with time and as they age? Rustagi: One of the most important things is that before you start investing, you need to have a financial plan in place. Generally, the mistakes that we make at this age is to delay the investment process. What we need to understand is there is something called power of compounding. That works the best over a longer period.

The more time you give your money to grow, the more you benefit in terms of returns that you get. Don't delay that. Also remember, every 10 years you delay the process, you have to invest 3 times to achieve the same amount that you would have achieved if you started investing 10 years ago.

Second important thing is we don't give due importance to risk management. What is risk management? Thats basically assurance that we have adequate risk cover and what is the risk cover we need? We need risk cover for life, for health and also for property. And the best way is to not start investing haphazardly.

Today, the equity market is doing very well so let me put my money in equity market. For the last couple of years equity market is not doing very well, let's put our money in bonds because that is where the money is coming. That is not the right way of investing.

The simple way is to establish your goals. All of us have goals, goals that we want to achieve in short, medium and long term. Once you do that, assign a time horizon to each one of them. For example, we know that we will need money for our children's education after 15 years. The time horizon is 15 years.

We need money for let's say another 5 years for their marriage, or another 30 years for retirement. So assign a time horizon for each one of them and set a target and whenever you are setting a target remember to take inflation into consideration.

These are simple steps that we need to take and once you do this, it can automatically decide your asset allocation. Asset allocation is basically a strategy whereby we decide how much money should go into different asset classes, whether it should go into gold, into debt or equity. I am talking about the financial assets.

We also need to understand the risk. What is the risk that we have? Whenever we talk about risk, the only risk we think of is losing our capital. But there is another bigger risk we generally tend to ignore. That is inflation. We need to beat inflation, we all need to understand there is something called real rate of return that is real rate of return minus inflation should be positive.

Otherwise, your money is just going in numbers, not in value. There you can invest in equity. When you come with a clear time horizon in mind, even if the markets are volatile, you won't be worried. If you get into equity without a clear time horizon in mind, you dont know what to do with this. So every time the market turns volatile you just want to get out.

These are simple steps that you can start with and I am sure you can achieve all the goals that you have in your life.

Abidi: So it is not equity or financial products that are the real monsters but it is inflation which is a real monster that you need to be worry of. Lets open the floor and who has a question for our experts?

Guest: If I have to invest in mutual funds would you suggest a one time investment like a huge amount or should I follow the systematic investment plan (SIP)? Which should benefit me more and what kind of funds should I invest in also?

Bodke: One must go in for SIP because that helps ride out the upturns and downturns in a market rather than putting money in any mutual fund. As far as the kind of mutual fund that you are looking for, I would advise going in for a diversified blue-chip equity fund for a first time investor because as the name blue-chip suggests, a company has become a blue-chip by weathering the vicissitudes of the upturns and downturns in the economy.

Hence all the companies that qualify for being blue-chips are the ones which should be able to give you steady returns with the risk which is not too high and also to go in with those mutual funds that have a proven track record over a medium to long term. When I say medium to long term, I mean 3 to 5-10 years and how their funds have performed and what kind of governance practices those funds have.

Abidi: So far we have been talking about asset allocation, discipline while investing in markets and also the magic of compounding. In fact a research shows that if you were to begin investing Rs 5,000 a month for the next 30 years or so, you would yield a compounded return of Rs 2.7 crore. If you were to delay that investment by 5 years your corpus at the end of those 30 years would only be about Rs 1.3 crore. So that is the magic of compounding and that is the incentive to begin investing as early as possible. That is also something that Hemant would agree with and advice.

Guest: The focus right now in our lives is childrens fund that we want to invest in and with payouts as often as every four years or during their college, what is the best manner of achieving the most important aspect of how would we be able to bring out those payouts as easily as possible.

Rustagi: First in the initial stage you should be focusing on asset class which can help you in terms of getting higher returns and because you would be accumulating over a period of time and investing in a disciplined manner, the risk of volatility which exists in the market place is a natural phenomenon. It is automatically taken care of.

You do have other options like - children plans of insurance companies but, they are generally invested in a conservative manner. If you have a time horizon of 15 years or thereabouts, you need to accumulate as much as possible. There the best asset class is equity.

First you start accumulating money and because equity is very tax efficient after one year whatever gains you have they all become tax free. There is another option, let us say if you have a time horizon of 15 years. After completion of 14 years, you take out money from equity and invest into debt related products so that all the gains that you accumulated over the next 14 years are all preserved and from there you can start withdrawing money as and when you require for your child's education.

Guest: Should I keep investing monthly or should I collect a big amount and put it all together or is there something where I can keep putting the monthly money in?

Bodke: There is no need for you to wait for a big lumpsum. You can start even as low as Rs 5,000 kind of an amount on a monthly basis. There is no need for you to wait to accumulate a large amount.

Guest: Where do I put it? What should I do with it?

Bodke: One could look at investing through mutual funds in an equity plan. One can go in for systematic investment plan wherein whatever time horizon one has in mind, five years or ten years of investments, one can keep on investing a certain amount every month or every quarter.

Being a disciplined and regular investor can help one cope up with the ups and downs in the market.

Guest: What do you think about this Jeevan Asha, Jeevan Anand Policies. I have done Jeevan Anand with my daughter so I just wanted to know, is it a good thing that I put my money into or there are better opportunities where I could put my money into?

Rustagi: This is an insurance plan. We need to understand why we take insurance, to risk cover. These plans that you are talking about basically are domain plans. These are more of investment than insurance. These are all plans which are going to give you return of 6-7-8% max.

If you are investing in these plans for the next 10-15 years and if inflation is going to be rising at 7%, your return is going to be 7% or even 6% and at the end of the day, you have not got anything. What we need to understand is that we have to separate our investment needs from insurance needs.

Insurance should be pure risk cover. For that you should go with term plan. What this term plan does is basically it is a very cheap one and it can give you high risk cover which is what you need. Investments go into options like mutual funds which are more tax efficient and also have the potential to give you higher return.

Do a combination of term plan and investment in mutual funds rather than going into a very-very conservative investment.

Abidi: Also calculate what are the gains from tax saving and the losses that are not accounted for inflation are matched and whether it is positive at the end of it.

Guest: Where do you see the rupee-dollar stabilizing at because it used to be 45 and now it is 55?

Bodke: Over the last one year we have seen that the Indian economy's growth rate has come down. We have seen foreign flows slowing down in India. Inflation has been stubbornly high and sticky and it has been difficult for the Reserve Bank of India to lower rates because of inflation being sticky.

All these factors have been responsible for the steep fall in the rupee that one has seen. However, the government has been cognizant of the fact that the rupee has fallen and it is taking steps to ensure that the investment cycle which has basically come to a halt, comes up again. It is putting in place policies to revive growth.

It is then expected that the foreign investor should take a cue and should start coming back to India in large numbers. These measures in our view will help revive the sentiment for the economy as well as on the rupee front. One can see the rupee strengthening from the current levels. So from levels of 55 one should not be surprised if the rupee were to go back to a level of 52 to 53 over the next three to six months.

Abidi: So 45 is totally out of the question right now that is too optimistic perhaps.
Abidi: Perhaps one of the biggest lessons that an investor needs to know is how to structure their portfolios and what kind of asset allocation suits their risk profile. We get a lot of portfolios on our website moneycontrol.com and Hemant today has selected one of the portfolios that's in most dire need of repair and he is going to tell us what's wrong with the portfolio and how it can be rectified?

Rustagi: I have selected a portfolio of Neeraj Katoch. He is 34 years old. He wants to invest some money and he has identified some goals. His goals are like he wants to invest for his son's education, marriage and his own retirement.

Now why it requires attention immediately is because the most important thing in the financial plan is to establish your goals, have a time horizon in place and also set a target. While he has done the first part alright, he hasn't basically set a target of how much he needs to invest for each one of these. Besides, the time horizon which is absolutely necessary because based on these two factors you decide what kind of asset allocation you are going to have in the portfolio. I am going to help him out because he has mentioned that he is 34 years old and he has a son who is 3 years old.

I am assuming that for his son's education, he will need money after 15 years. Assuming that he needs around Rs 30 lakh and because the time horizon for all the 3 goals is 15

years plus, I am recommending that he should invest this money into equity fund through a SIP.

If he has a target of Rs 30 lakh, he needs to invest Rs 4000 assuming an annualized return of 12% to achieve the first goal. The second goal here for him is basically for his son's marriage, for which the time horizon is around 23 years. Assuming that he has a target of Rs 20 lakh, he needs to invest around Rs 1500 per month.

For his own retirement if the target is around Rs 1 crore and the time horizon is 26 years, he needs to invest around Rs 5000 to achieve the goal of Rs 1000. In all he needs to invest Rs 10500 whereas he has mentioned that he can invest only Rs 3000.

Now the key for him is to start investing. He should not wait till the time when he can invest Rs 10500 because then he will not get the impact of the power of compounding the way he would get it now. I believe that he should prioritize his goals, maybe start investing for his son's education first and then he can start investing for further goals as and when he has extra money.

But before starting his investment process, I would like him to focus on the risk management too which means that he must ensure that he is adequately insured in terms of life insurance and health insurance. He also needs to create an emergency reserve which should be equivalent to 3-6 months of monthly expenses.

The whole idea is that if you have an emergency fund in case you need money, you will not disturb your long term investment. He should go for life insurance because he is young, 34 years old and he should go for a term plan. The thumb rule is it must be equivalent to his 10 years of income. For health insurance, he should opt for a family floater plan because it is a young family.

I believe if he follows this process and starts this process immediately, he can definitely achieve his goal. Abidi: And talking of portfolios and asset allocations our audience had divided the Rs 25000 into various asset categories. You have gone through it. So who has the best asset allocation?

Bodke: I would say that Jasmine Shah because she has allocated it over different asset classes. She has looked at investing a fifth of the investments in mutual funds through an SIP, a fifth of investments in gold, a fifth on investments in fixed deposits which will ensure a regular income, Rs 5000 investments directly in equities and the rest Rs 5000 in a child policy. So I would go with Jasmine Shah.

Abidi: So you are well on your way to being an informed investor. But any trends that you might have noticed in terms of the way money has been allocated?

Bodke: Yes I think I have noticed two trends. There have been a couple of participants who have put all their eggs in one basket and invested only in fixed deposits. Now we have discussed how we need to have a plan which is able to comfortably beat inflation.

If you were to invest all your funds in a fixed deposit plan then you can't expect to beat inflation. The second trend I have noticed is that some people have put a disproportionate amount of money in an asset which is currently doing well. This is what I call a recency effect.

You tend to put a lot of money in an asset that has done well recently and that is why around 80% of the money has been put in by someone only in gold and silver. It is not possible that the asset class that has done well over the last few years will continue to give you a super normal return over a very long term. Hence, you must allocate assets over a wide range of asset classes.