Balancing your investment options

I was reading an interesting report from a foreign brokerage house recently. It contained data on the returns given by various asset classes over the years (Please refer to the table). As you may notice,there was no one single top performer over different time periods. You may also notice in the chart attached,that although fixed deposits rule the roost,equity holdings spiked precisely at the wrong times.

I believe that the only way to avoid getting whipsawed is to maintain a constant asset allocation. By doing so we will protect ourselves from the psychological and financial ill-effects of “performance chasing”.

Here are a few ways
To Go About It
* Follow a thumb rule stated by John Bogle of Vanguard that the amount of equity owned by you should be 80 – your age. Hence if you are 30 years you should have 50 per cent in equity.

* Get a grip on the amount of volatility you can endure and adjust your equity component accordingly. Rather than relying on intuition it may be preferable to undergo psychometric testing to help you assess your risk tolerance. Mind you,risk and volatility are not the same. Equities as a whole are more volatile than debt instruments but purchasing equities when valuations are low is actually LESS risky than moving into bonds at the wrong time. However your comfort level to equity will depend on your psychological make-up and financial situation,both of which will be independent of the prevailing market index levels.

*Maintain a sense of balance:
Your portfolio should include assets which will meet your liquidity as well as growth requirements. Too much of one over another is not advisable. While you should rely on equities to meet your longer term goals (those beyond five years),fixed deposits and short-term debt funds are more suitable for shorter time horizons. Alternative assets such as precious metals,real estate,private equity etc. protect you against inflation and also provide returns which are less correlated to mainstream investment classes such as equity and debt albeit,at the cost of liquidity.

* Use the right vehicle:
Determining the desired balance between different asset classes is only part of the game. This must be followed by honing in on the right vehicle within the asset class. For instance,within fixed income would you prefer fixed deposits,debt funds,bonds or loans Within equities,would you prefer investing directly in equities or opt for the diversified equity mutual fund route,would you prefer buying gold coins or units of Gold ETFs etc.

Besides these,ensure that
* You rebalance periodically:
Movements in market prices will lead to passive changes in your asset allocation even though you may not actively alter it. For instance if your stocks move up by an average of 20% in one year,your original equity : debt balance of 60:40 will automatically change to 72 : 28. Hence it is prudent to revisit it once a year or so in order to restore it to its original balance. Of course,when one class is rising fast,it is mentally difficult to book profits as we would fear an opportunity loss but you must be resolute.

* You do not ignore the tax angle:
Everytime you rebalance,you will be liable to pay capital gains tax on the same. Hence rebalancing too frequently is not advisable. Besides,the very aim of asset allocation is to obviate the hazards involved in market timing and predictions and this is defeated when we keep a constant on the markets with the aim of rebalancing.

You may engage in auto-rebalancing by investing in balanced funds or asset allocation funds. These invest in an array of assets in certain pre-defined percentages and the fund manager ensures that the balance is redressed once every quarter or so. You will not be liable to pay tax when this rebalancing is undertaken. When you invest through this route,you will be liable to pay tax only when you redeem your units and not each time the fund manager rebalances.

To conclude,as in everything else in life,a balanced approach to investments will place you in a better position to achieve your financial goals as well as in ensuring peace of mind.

Author is Vice President,Parag Parikh Financial Advisories